On September 30 of the current year, a U.S. company entered into a futures contract to hedge the value of its
inventory. The inventory was reported on the balance sheet at its cost of $250,000 on September 30. On
December 31, the market value of the inventory had decreased to $175,000. The entity had a gain of
$74,500 on the futures contract at December 31. What is the proper accounting for this hedging transaction
on the December 31 year-end financial statements, assuming that the hedge is considered to be highly
a. Other comprehensive income will increase by $74,500.
b. Other comprehensive income will decrease by $500.
c. Net income will increase by $74,500.
d. Net income will decrease by $500.
Choice "d" is correct. This hedge is classified as a fair value hedge because it is being used to hedge the
value of the inventory. Therefore, the gain on the fair value hedge must be recognized in earnings, along with
the loss on the inventory, for a net decrease in net income of $500:
Gain on derivative= $74,500
Loss on inventory= $175,000 FV - $250,000 BV = $(75,000)
Net loss on fair value hedge= $(75,000) loss+ $74,500 gain= $(500) loss
In order for a financial instrument to be a derivative for accounting purposes, the financial instrument must:
I. Have one or more underlyings.
II. Require an initial net investment.
a. I only.
b. II only.
c. Both I and 11.
d. Neither I nor II.
Choice "a" is correct. SFAS No.133 defines derivatives for accounting purposes as having one or more
underlyings (and one or more notional amounts), and as not requiring an initial net investment (or having an
initial net investment that is smaller than would be required for other types of similar contracts).
derivative may be designated and qualify as a fair value hedge if a set
of criteria relating to the derivative and the hedged item are met. The most significant criteria are:
1. There is formal documentation of the hedging relationship between the derivative and the hedged item.
2. The hedge must be expected to be highly effective in offsetting changes in the fair value of the hedged
item and the effectiveness is assessed at least every 3 months.
3. The hedged item is specifically identified.
4. The hedged item presents exposure to changes in fair value that could affect income.
A change in the fair value of a derivative qualified as a cash flow hedge is determined to be either effective in
offsetting a change in the hedged item or ineffective in offsetting such a change. How should the effective
and ineffective portions of the change in value of a derivative which qualifies as a cash flow hedge be
reported in financial statements?
1. Effective portion in ?
2. Ineffective portion in?
Choice "c" is correct. Changes in (gains and losses on) the effective portion of a cash flow hedge are
deferred and reported in "other comprehensive income;" changes in the ineffective portion are reported in
current income. Gains and losses which are deferred and reported in "other comprehensive income" must be
reclassified and recognized in income in the period(s) in which the hedged item affects income.
Selected information from the accounts of Row Co. at December 31, Year 5, follows:
Total income since incorporation $420,000
Total cash dividends paid 130,000
Total value of property dividends distributed
Excess of proceeds over cost of treasury stock sold, accounted for using the cost method
In its December 31, Year 5, financial statements, what amount should Row report as retained earnings?
Choice "a" is correct. Look at each item given and decide how it affects retained earnings: income since
incorporation equals unadjusted ending retained earnings (RE), that is, current year income is included; cash
dividends is a direct deduction from RE on the date of declaration; property dividends are deducted from RE
at market value on the date of declaration; the excess proceeds from the sale of treasury stock is considered
additional paid-in capital. Thus, ending RE = unadj. RE -cash dividends - property dividends = $420,000 -
$130,000- $30,000 = $260,000.
Choice "b" is incorrect. This amount does not include the effect of the property dividends. Property dividends
are deducted from RE at market value on the date of declaration.
Choice "c" is incorrect. This amount incorrectly includes the proceeds from the sale of the treasury stock.
The cost method of accounting for treasury stock affects retained earnings only if the shares are sold below
cost and the difference exceeds any additional paid-in capital from treasury stock.
Cyan Corp. issued 20,000 shares of $5 par common stock at $10 per share. On December 31, Year 1,
Cyan's retained earnings were $300,000. In March, Year 2, Cyan reacquired 5,000 shares of its common
stock at $20 per share. In June, Year 2, Cyan sold 1,000 of these shares to its corporate officers for $25 per
share. Cyan uses the cost method to record treasury stock. Net income for the year ended December 31,
Year 2, was $60,000. At December 31, Year 2, what amount should Cyan report as retained earnings?
Choice "a" is correct. $360,000 retained earnings at 12/31 /Year 2 ($300 + $60). Because all treasury stock
transactions were recorded under the "cost method," and the resale of treasury stock was at a price that
exceeded its acquisition price, none of the treasury stock transactions affected retained earnings.
Choice "b" is incorrect. The $5,000 gain [1 000 shares x ($25 sale price - $20 purchase price)] is recorded as
a credit to Additional Paid-in Capital-Treasury Stock, not as a credit to retained earnings. Only losses in
excess of APIC-Treasury Stock are booked to retained earnings.
In September, Year 1, West Corp. made a dividend distribution of one right for each of its 120,000 shares of
outstanding common stock. Each right was exercisable for the purchase of 1/100 of a share of West's $50
variable rate preferred stock at an exercise price of $80 per share. On March 20, Year 5, none of the rights
had been exercised, and West redeemed them by paying each stockholder $0.10 per right. As a result of this
redemption, West's stockholders' equity was reduced by:
Choice "c" is correct. In Year 1, no dividend was recorded since none of the rights were exercised and no
value was assigned. In Year 5, redemption reduced equity by $12,000 [120,000 rights x $.10 per share].
How would the declaration of a 15°/o stock dividend by a corporation affect each of the following?
1. Retained earnings
Decrease to retained earnings - No effect on shareholder's equity.
Rule: A stock dividend (less than 20-25°/o of stock outstanding) is treated by transferring the FMV of the stock
dividend at declaration date from retained earnings to capital stock and paid-in capital. There is no effect on
total shareholder's equity because all transfers take place within shareholder's equity.
Shares of its own stock held by a corporation should
be recorded as treasury stock and shown as a reduction in the stockholders' equity section of the B/S.
Hoyt Corp.'s current balance sheet reports the following stockholders' equity:
5°/o cumulative preferred stock, par value $100 per share;
2,500 shares issued and outstanding $250,000
Common stock, par value $3.50 per share; 100,000 shares issued and outstanding 350,000
Additional paid-in capital in excess of par value of common stock 125,000
Retained earnings 300,000
Dividends in arrears on the preferred stock amount to $25,000. If Hoyt were to be liquidated, the preferred
stockholders would receive par value plus a premium of $50,000. The book value per share of common stock
Choice "d" is correct. $7.00 book value per common share.
Preferred stock 250,000
Common stock 350,000
Additional paid-in capital 125,000
Retained earnings 300,000
Total stockholders equity 1,025,000
Less: PR stock interest (325,000)*
Total shares O/S / 100,000
Book value per share $ 7.00
* Par value preferred 250,000
Premium on preferred 50,000
Div. In arrears 25,000
Total preferred stock interest 325,000
Any preferred shareholder interest must be removed from shareholders' equity before computing book value
Ole Corp. declared and paid a liquidating dividend of $100,000. This distribution resulted in a decrease in
Yes - No.
By definition, a liquidating dividend is one in which the company is returning a portion of capital originally
contributed to the company in excess of retained earnings. A (pure) "liquidating dividend" implies there is no
"retained earnings" left to decrease.
Posy Corp. acquired treasury shares at an amount greater than their par value, but less than their original
issue price. Compared to the cost method of accounting for treasury stock, does the par value method report
a greater amount for additional paid-in capital and a greater amount for retained earnings?
No - No.
Compared to the cost method for reporting treasury stock, the par value method will report a lower amount for
additional paid-in capital (APIC) and the same amount for retained earnings.
The easiest way to solve this problem is to make a set of assumptions consistent with the facts and record the
Treasury stock 80
Par value method
Treasury stock 60
Note: The only difference is that a portion of the debit is transferred from treasury stock to APIC, thereby
reducing the credit balance of APIC.
Grid Corp. acquired some of its own common shares at a price greater than both their par value and original
issue price but less than their book value. Grid uses the cost method of accounting for treasury stock. What
is the impact of this acquisition on total stockholders' equity and the book value per common share?
Total stockholders' equity
Book value per share
Decrease - Increase.
The acquisition of treasury stock at a price less than their book value will:
1. Decrease stockholders' equity in total. All treasury stock transactions decrease total equity.
2. Increase book value per share. Book value per share is based on the number of outstanding common
shares, which is reduced by the acquisition of treasury stock (the denominator is reduced). The
numerator (book value) is also reduced by the cost to purchase the shares, but the overall effect on the
ratio is an increase in book value per share. For example, if book value were $1,000 and there were 100
common shares, the book value per common share would be $10. If 10 shares were repurchased for $8
(which is less than the original book value per share), the new book value would be $920 and the reduced
number of shares would be 90, thus, resulting in a new book value per common share of $10.22, which is
larger than the original $10.
How would the 5% stock dividend affect the additional paid-in capital and retained earnings amounts reported
in Gee's Year 2 statement of owners' equity
2. RETAINED EARNINGS
A 5% stock dividend is a true stock dividend, as opposed to a stock split effected in the form of a dividend.
The fair market value of the stock dividend at declaration date is capitalized (transferred) from retained
earnings to capital stock and paid-in capital.
Instead of the usual cash dividend, Evie Corp. declared and distributed a property dividend from its
overstocked merchandise. The excess of the merchandise's carrying amount over its market value should
b. Reported as a separately disclosed reduction of retained earnings.
c. Reported as an extraordinary loss, net of income taxes.
d. Reported as a reduction in income before extraordinary items.
Choice "d" is correct. A loss is recognized for the merchandise's carrying amount over its market value. This
results in a reduction in income before extraordinary items.
Rule: Dividends declared and paid in the form of assets other than cash are recorded by the distributing
corporation at fair market value at date of declaration.
On March 1, Rya Corp. issued 1,000 shares of its $20 par value common stock and 2,000 shares of its $20 par value convertible preferred stock for a total of $80,000. At this date, Rya's common stock was selling for $36 per share, and the convertible preferred stock was selling for $27 per share. What amount of the proceeds should be allocated to Rya's convertible preferred stock?
Choice "c" is correct. $48,000 allocated to preferred.
Rule: Allocate "issue proceeds" of a basket purchase or sale of convertible preferred stock based on relative
fair market values:
Shares $ Fair Value Basis
Common stock 1000 x 36 = $36,000 $32,000
Preferred stock 2000 x 27 =54, 000 48,000
Total fair value $90,000 $80,000
Allocate to preferred: 54/90 x $80,000 = $48,000
When collectibility is reasonably assured, the excess of the subscription price over the stated value of the no par common stock subscribed should be recorded as:
a. No par common stock.
b. Additional paid-in capital when the subscription is recorded.
c. Additional paid-in capital when the subscription is collected.
d. Additional paid-in capital when the common stock is issued.
Choice "b" is correct. When collectibility is reasonably assured, the excess of the subscription price over the
stated value of the no par common stock subscribed should be recorded as additional paid-in capital (APIC)
when the subscription is received.
Entry to record subscription of 1,000 shares of common stock ($5 stated value or par value) at a price of $18
with down payment of $3 per share:
Cash (1,000 x $3) 3,000
Subscription received - c/s 15,000
Common stock subscribed (1,000 shs x $5) 5,000
Additional paid-in capital ($13 x 1,000) 13,000
Note: This is same "APIC" as if the stock had been fully paid for and issued.
A corporation issuing stock should charge retained earnings for the market value of the shares issued in a
a. Employee stock bonus.
b. Pooling of interests.
c. 10°/o stock dividend.
d. 2-for-1 stock split.
Choice "c" is correct. 1 Oo/o stock dividend.
1. Charge retained earnings for the market value of shares issued for stock dividend of less than 20-
2. Use par value if more than 20-25°/o stock dividend.
3. If between 20-25°/o use either par or FMV.
Stock dividends on common stock should be recorded at their fair market value by the investor when the
related investment is accounted for under which of the following methods?
No - No.
Rule: Stock dividends and stock splits are not considered income to the recipient.
Therefore, investors do not record stock dividends at fair market value. They simply reallocate the
investment account balance (under either method -- cost or equity) over more shares so that value per share
On January 1, Year 1, Ward Corp. granted stock options to corporate executives for the purchase of 20,000 shares of the company's $20 par value common stock at $48 per share. All stock options were exercised on
December 28, Year 1. Using an acceptable option pricing model, Ward calculated total compensation cost of $240,000. The quoted market prices of Ward's $20 par value common stock were as follows:
January 1, Year 1 $45
December 28, Year 1 60
As a result of the grant and exercise of the stock options and the issuance of the common stock, Ward's additional paid-in capital increased by:
$800,000 increase to additional paid-in capital.
January 1 Journal Entry
Compensation expense $240,000
APIC - Stock options 240,000
December 28 Journal Entry
Cash ($48 x 20,000 shares) $960,000
APIC - Stock options $240,000
Common stock (20,000 x $20) $400,000
On January 1, Year 1, Lord Corp. granted stock options for 10,000 shares at $38 per share as additional
compensation for services to be rendered over the next three years. Using an acceptable option pricing
model, Lord calculated total compensation cost of $90,000. The options are exercisable during a 4-year
period beginning January 1, Year 4, by grantees still employed by Lord. Market price of Lord's stock was $47
per share at the grant date. No stock options were terminated during Year 1. In Lord's Year 1 income
statement, what amount should be reported as compensation expense pertaining to the options?
The compensation should be allocated over the period for which the services are performed.
Fair value of options at grant date $90,000
Services for 3 years 3
Compensation expense - Year 1 $30,000
On March 4, Year 1, Evan Co. purchased 1,000 shares of LVC common stock at $80 per share. On
September 26, Year 1, Evan received 1,000 stock rights to purchase an additional 1,000 shares at $90 per
share. The stock rights had an expiration date of February 1, Year 2. On September 30, Year 1, LVC's
common stock had a market value, ex-rights, of $95 per share and the stock rights had a market value of $5
each. What amount should Evan report on its September 30, Year 1, balance sheet for investment in stock
5000/(5k+95k) x 80,000=4000
Cash flow statement
--During Year 2, equipment costing $40,000 was sold for cash.
Depreciation expense $33,000
Increase in Accumulated depreciation (11,000)
Depreciation on equipment sold $22,000
Gain on sale of equipment 13,000
What are the proceeds of the Sale I.e what are the cash flows? J/e please....
Cash 31,000 **
Acc depreciation 22,000 ****
22,000 depreciation attributable to the equipment
Proceeds from the sale of equipment is under what activity ?
Cash flow Statement under IFRS
Cash dividends paid, under U.S. GAAP.
[F] Financing activity.
[I] Investing activity.
[O] Operating activity.
FINANCING. Under IFRS, cash dividends paid may be classified as a financing activity
or an operating activity.
Redemption of bonds payable.
[F] Financing activity.
[I] Investing activity.
[O] Operating activity.
Choice [F] is correct. FINANCING.
At December 31, Year 1, Eagle Corp. reported $1,750,000 of appropriated retained earnings for the
construction of a new office building, which was completed in Year 2 at a total cost of $1,500,000.
In Year 2, Eagle appropriated $1,200,000 of retained earnings for the construction of a new plant.
Also, $2,000,000 of cash was restricted for the retirement of bonds due in Year 3. In its Year 2
balance sheet, Eagle should report what amount of appropriated retained earnings?
a. $1,200,000 b. $1,450,000 c. $2,950,000 d. $3,200,000
Rule: When the purpose of the appropriation has been achieved, it should be restored to
unappropriated retained earnings.
Choice "a" is correct. $1,200,000 appropriated retained earnings at Dec. 31, Year 2 (for the
construction of a
new plant only).
Choices "b" and "c" are incorrect. When the new ($1,500,000) office building was completed in Year
$1,750,000 was restored to unappropriated retained earnings.
Choice "d" is incorrect. "Cash restricted for the retirement of bonds" (an asset account called
cash") typically reduces regular cash and does not affect retained earnings. (There may also be an
appropriation, but this would have to be specifically mentioned in the question.)
On December 1, Line Corp. received a donation of 2,000 shares of its $5 par value common stock from
stockholder. On that date, the stock's market value was $35 per share. The stock was originally
$25 per share. By what amount would this donation cause total stockholders' equity to decrease?
Choice "d" is correct. $0 decrease in total stockholders' equity due to donation of its own stock
from a stockholder because there is no cost to the corporation. The entry would be:
DR Donated treasury stock(@ FMV)
CR Additional paid-in capital (@ FMV)
Both accounts enter into total stockholders' equity; therefore, there is no change in total
stockholders' equity. When (if) the shares are reissued, the entry would be:
DR Cash(@ sales price)
DR Additional paid-in capital (for sp < carrying value)
CR Donated treasury stock(@ carrying value) additional paid-in capital
(for sp > carrying value)
Quoit, Inc. issued preferred stock with detachable common stock warrants. The issue price exceeded the
sum of the warrants' fair value and the preferred stock's par value. The preferred stock's fair value was not
determinable. What amount should be assigned to the warrants outstanding?
a. Total proceeds.
b. Excess of proceeds over the par value of the preferred stock.
c. The proportion of the proceeds that the warrants' fair value bears to the preferred stock's par value.
d. The fair value of the warrants.
hoice "d" is correct. The fair value of the warrants is credited to paid in capital.
In a compensatory stock option plan for which the grant and exercise dates are different, the stock options
outstanding account should be reduced at the:
a. Date of grant.
b. Beginning of the vesting period.
c. Beginning of the service period.
d. Exercise date.
Choice "d" is correct. Stock options outstanding are reduced at the exercise date.
Choice "a" is incorrect. Stock options outstanding are increased at the date of grant.
Choice "b" is incorrect. The beginning of the vesting period is not used.
Choice "c" is incorrect. The beginning of the service period is the beginning of the period over which the
compensation expense is amortized.
Universe Co. issued 500,000 shares of common stock in the current year. Universe declared a 30o/o
dividend. The market value was $50 per share, the par value was $10, and the average issue price
per share. By what amount will Universe decrease stockholders' equity for the dividend?
b. $1,500,000 c. $4,500,000 d. $7,500 ,000
Choice "a" is correct. The net effect on Universe's stockholders equity is zero, as the reduction
earnings is offset by an equal increase in common stock.
DR Retained earnings (.30 x 500,000 x $10) $1,500,000
CR Common stock ($10 per value) $1,500,000
Choices "b", "c", and "d" are incorrect, per the above.
Porter Co. began its business last year and issued 10,000 shares of common stock at $3 per share.
value of the stock is $1 per share. During January of the current year, Porter bought back 500
shares at $6 per share, which were reported by Porter as treasury stock. The treasury stock shares
were reissued later in the current year at $10 per share . Porter used the cost method to account
for its equity transactions. What amount should Porter report as paid-in capital related to its
treasury stock transactions on its balance sheet for the current year?
a. $1,500 b. $2,000 c. $4,500 d. $20,000
Choice "b" is correct. Using the cost method , the treasury stock transactions include the
reissuance of the treasury shares at $10 per share ($4 per share to APIC x 500 shares) , or $2,000.
The additional paid-in capital from the original issuance of the stock is not paid-in capital
related to the treasury stock and is not
Baker Co. issued 100,000 shares of common stock in the current year. On October 1, Baker
repurchased 20,000 shares of its common stock on the open market for $50.00 per share. At that
date, the stock's par value was $1.00 and the average issue price was $40.00 per share. Baker uses
the cost method for treasury stock transactions. On December 1, Baker reissued the stock for
$60.00 per share. What amount should Baker report as treasury stock gain at December 31?
b . $200,000 c. $400,000 d. $980,000
Choice "a" is correct. Corporations are not permitted to report income statement gains and losses
from treasury stock transactions. Instead, treasury stock "gains and losses" are reported as
direct adjustments to stockholders' equity. Gains are recorded by crediting APIC - Treasury Stock,
while losses are recorded by first reducing any existing APIC - Treasury Stock to $0, and then
debiting any additional loss to Retained Earnings.
Baker's treasury stock transactions would be recorded as follows: 10/1 - Repurchase of Treasury
DR Treasury stock CR Cash
12/1 - Resell Treasury Stock
DR Treasury stock $1,000 ,000 CR Cash $1,000,000
12/1 - Resell Treasury Stock
DR Cash $1,200 ,000
CR Cash $1,000,000
12/1 - Resell Treasury Stock
DR Cash $1,200 ,000
CR Treasury stock $1,000 ,000
CR APIC - Treasury stock 200,000
Deck Co. had 120,000 shares of common stock outstanding at January 1, Year 2. On July 1, Year 2,
40,000 additional shares of common stock. Outstanding all year were 10,000 shares of
nonconvertible cumulative preferred stock. What is the number of shares that Deck should use to
calculate Year 2 earnings per share?
Choice "a" is correct. 140,000 shares of common stock is the weighted average for earnings per
calculation is as follows:
1-1-Year 2: Outstanding all year120,000
7-1-Year 2: 40,000 issued x 6/12 Weighted average20,000
Which of the following items, if dilutive and if other conditions are met, would enter into the
the weighted average shares outstanding to be used in the basic earnings per share (basic EPS)
I. Stock options.
II. Contingent shares.
a. I only.
b. II only.
c. Both I and II.
d. Neither I nor II
Choice "b" is correct. Contingent shares (that are dilutive) are included in the calculation of
basic earnings per share (EPS) if (and as of the date) all conditions for issuance are met. Stock
options do not enter into the calculation of basic EPS.
Choices "a" and "c" are incorrect , because stock options do not enter into the calculation of the
but will enter into the calculation of dilutive EPS if dilutive (i.e., the average market price of
the common stock
during the period exceeds the exercise price of the option).
In computing the weighted-average number of shares outstanding during the year, which of the following
midyear events must be treated as if it had occurred at the beginning of the year?
a. Declaration and distribution of stock dividend.
b. Purchase of treasury stock.
c. Sale of additional common stock.
d. Sale of preferred convertible stock.
Choice "a" is correct. In computing the weighted-average number of shares outstanding for earnings per
share (EPS) determination, a stock dividend (or a stock split) to the same class of shareholders must be
retroactively recognized and treated as if it had occurred at the beginning of the year. In addition, EPS for all
prior periods presented must be adjusted as though the shares had been outstanding for the entire period
Which one of the following is not considered contingent shares for purposes of computing EPS?
a. Shares issuable upon achieving a specific net income target.
b. Shares issuable upon exercise of a stock option.
c. Shares issuable upon the passage of a specific period of time.
d. Shares issuable upon the issuance of a patent.
Choice "b" is correct. Shares issuable upon the exercise of a stock option are not considered contingent
shares as the option holder is required to pay the strike price to exercise the options.
Ute Co. had the following capital structure during Year 1 and Year 2:
Preferred stock , $10 par, 4°/o cumulative, 25,000 shares issued and outstanding Common stock , $5 par, 200 ,000 shares issued and outstanding
Ute reported net income of $500,000 for the year ended December 31, Year 2. Ute paid no preferred dividends during Year 1 and paid $16,000 in preferred dividends during Year 2. In its December 31, Year 2, income statement , what amount should Ute report as basic earnings per share?
Choice "b" is correct. $2.45 earnings per share.
Net income$ 500,000
Less: Cumulative preferred(10,000)
Stock dividend "requirement" ($10 par x 25,000 shs x 4°/o ) (10,000)
Income available to common shares490 ,000
Divide by average common shares O/S. 200,000
Basic earnings per common share $ 2.45
Note: Since the preferred stock dividends are cumulative, when they are declared or paid is not relevant
West Co. had earnings per share of $15.00 for the current year before considering the effects of
convertible securities. No conversion or exercise of convertible securities occurred during the
year. However, possible conversion of convertible bonds would have reduced earnings per share by
$0.75. The effect of possible exercise of common stock options would have increased earnings per
share by $0.10. What amount should West report as diluted earnings per share for the current year?
Choice "c" is correct. $14.25 diluted earnings per share.
EPS before the effect of any convertibles
Possible conversion of bonds Diluted earnings per share
Note: The possible exercise of common stock options would increase EPS by $0.10, so they are not
to the anti-dilution rule. Each potentially dilutive security is considered separately for its
On December 1 of the current year, Clay Co. declared and issued a 6o/o stock dividend on its 100,000 shares
of outstanding common stock. There was no other common stock activity during the year. What number of
shares should Clay use in determining basic earnings per share for the current year?
Choice "d" is correct. A 6°/o stock dividend equals 6,000 shares with a total of 106,000 shares outstanding
after the distribution of the dividend. Stock dividends and stock splits require restatement of the shares
outstanding before the stock dividend or stock split. Thus, the stock dividend would be treated as if it had
occurred at the beginning of the fiscal year
When computing the weighted average of common shares outstanding for basic earnings per share,
convertible securities are:
b. Recognized whether they are dilutive or anti-dilutive.
c. Recognized only if they are anti-dilutive.
d. Recognized only if they are dilutive.
Choice "a" is correct. When computing basic earnings per share, convertible securities are ignored for
purposes of computing the weighted average of common shares outstanding.
On January 31, Year 2, Pack, Inc. split its common stock 2 for 1, and Young, Inc. issued a 5% stock dividend.
Both companies issued their December 31, Year 1, financial statements on March 1, Year 2. Should
Pack's Year 1 earnings per share (EPS) take into consideration the stock split, and should Young's Year 1 EPS take into consideration the stock dividend?
Rule: If stock dividend or a stock split (or reverse split) changes common stock outstanding , the
of EPS shall give retroactive recognition for all periods presented using the new number of shares
the reader's primary interest is presumed to be related to current capitalization.
The following information is relevant to the computation of Chan Co.'s earnings per share to be disclosed on
Chan's income statement for the year ending December 31:
Net income for 2002 is $600,000.
$5,000,000 face value 10-year convertible bonds outstanding on January 1. The bonds were issued four
years ago at a discount which is being amortized in the amount of $20,000 per year. The stated rate of
interest on the bonds is 9o/o, and the bonds were issued to yield10°/o. Each $1,000 bond is convertible
into 20 shares of Chan's common stock.
Chan's corporate income tax rate is 25°/o.
Chan has no preferred stock outstanding, and no other convertible securities. What amount should be used
as the numerator in the fraction used to compute Chan's diluted earnings per share assuming that the bonds
are dilutive securities?
Choice "c" is correct. The numerator in the diluted EPS computation is equal to income available to common
shareholders plus the after-tax interest expense that would not have been incurred if the bonds had been
converted. Note that the company is using straight-line amortization rather than effective interest
amortization. Under straight-line amortization, interest expense of $470,000 is reported each period. The
interest expense is equal to the interest payment of $450,000 ($5,000,000 face x 9°/o stated rate) plus the
discount amortization of $20,000. Therefore, the numerator is calculated as:
Income available to common shareholders + Interest of dilutive securities
= $600,000 + [$470,000 X (1 - 25°/o)] = $600,000 + $352,500 = $952,500
Mend Co. purchased a three-month U.S. Treasury bill. Mend's policy is to treat as cash equivalents all highly
liquid investments with an original maturity of three months or less when purchased. How should this
purchase be reported in Mend's statement of cash flows?
a. As an outflow from operating activities.
b. As an outflow from investing activities.
c. As an outflow from financing activities.
d. Not reported.
Choice "d" is correct. The U.S. Treasury bill is considered to be a cash equivalent item so purchasing the Tbill
merely changes the form of cash held, it does not change the cash position of the entity. Thus, the
purchase is not reported on the statement of cash flows.
The following are required disclosures of a statement of cash flows
under the direct method under U.S. GAAP.
a. The major classes of gross cash receipts and gross cash payments.
b. The amount of income taxes paid.
c. A reconciliation of net income to net cash flow from operations.
In preparing its cash flow statement for the year ended December 31, Reve Co. collected the
Gain on sale of equipment$ (6,000)
Proceeds from sale of equipment 10,000
Purchase of A.S., Inc. bonds (par value $200,000) (180,000)
Amortization of bond discount 2,000
Dividends declared (45,000)
Dividends paid 38,000)
Proceeds from sale of Treasury stock (carrying amount $65,000) 75,000
In its December 31, statement of cash flows , what amount should Reve report as net cash used in investing activities?
Choice "a" is correct. Investing activities include acquisitions and sales of long-term assets or
assets. Cash used equals $170,000 ($180,000 paid less $10,000 received from the sale of the
Fara Co. reported bonds payable of $47,000 at December 31, Year 1, and $50,000 at December 31, Year 2.
During Year 2, Fara issued $20,000 of bonds payable in exchange for equipment. There was no amortization
of bond premium or discount during the year. What amount should Fara report in its Year 2 statement of cash
flows for redemption of bonds payable?
Beginning balance 12/31 /Year 147,000
Add: issuance of bonds for equipment20,000
Less: redemption of bonds payable (17 ,000)
Ending balance 12/31/Year 50,000
Karr, Inc. reported net income of $300,000 during the current year. Changes occurred in several balance sheet accounts as follows:
Equipment $25,000 increase
Accumulated depreciation 40,000 increase
Note payable 30,000 increase
•During the year , Karr sold equipment costing $25,000, with accumulated depreciation of $12,000, for a gain of $5,000.
• In December, Karr purchased equipment costing $50,000 with $20,000 cash and a 12o/o note payable of $30,000.
• Depreciation expense for the year was $52,000.
In Karr's statement of cash flows , net cash used in investing activities should be
Choice "a" is correct. Cash used for investing activities is computed as follows:
Sale of equipment
Purchase of equipment Cash used for investing
Payment for the early retirement of long-term
bonds payable (carrying amount $370,000) $375,000
Distribution in Year 2 of cash dividend declared in Year 1 to preferred shareholders 31,000
Carrying amount of convertible preferred stock \in
Xan, converted into common shares 60,000
Proceeds from sale of treasury stock (carrying
amount at cost, $43,000) 50,000
During Year 2, Xan, Inc. had the following activities related to its financial operations:
Xan uses U.S. GAAP. In Xan's Year 2 statement of cash flows, net cash used in financing operations should
356,000 net cash used in financing operations
Payment to retire bonds $(375,000)
Payment of dividend (31,000)
Proceeds from Treasury stock 50,000
On July 1 of the current year, Dewey Co. signed a 20-year building lease that it reported as a
Dewey paid the monthly lease payments when due. How should Dewey report the effect of the lease
payments in the financing activities section of its statement of cash flows?
a. An inflow equal to the present value of future lease payments at July 1, less current year
b. An outflow equal to the current year principal and interest payments on the lease.
c. An outflow equal to the current year principal payments only.
d. The lease payments should not be reported in the financing activities section.
Choice "c" is correct. Cash payments made to reduce debt principal are properly reported as a
activity. Cash interest payments would be reported as a component of cash from operating
How should a gain from the sale of used equipment for cash be reported in a statement of cash flows using
the indirect method?
a. In investment activities as a reduction of the cash inflow from the sale.
b. In investment activities as a cash outflow.
c. In operating activities as a deduction from income.
d. In operating activities as an addition to income.
Choice "c" is correct. In a statement of cash flows using the indirect method, gain from the sale of used
equipment for cash should be reported in operating activities as a deduction from income.
Choice "a" is incorrect. In the investment activities section, cash inflow from the sale should be reported for
the entire proceeds from the sale.
Choice "b" is incorrect. In the investment activities section, cash outflows should be reported for purchases of fixed assets, stocks/bonds of other entities.
Choice "d" is incorrect. In the operating activities section, "loss" from the sale of used equipment should be reported as an addition to income.
Payne Co. prepares its statement of cash flows using the indirect method. Payne's unamortized bond discount account decreased by $25,000 during the year. How should Payne report the change in unamortized bond discount in its statement of cash flows?
a. As a financing cash inflow.
b. As a financing cash outflow.
c. As an addition to net income in the operating activities section.
d. As a subtraction from net income in the operating activities section
Choice "c" is correct. Amortization of bond discount is an income-related item; thus, it is almost automatically
an operating activity, not a financing activity. That knocks out two of the answers. Because the amortization
of the discount was originally subtracted to get to net income in the first place, it is added back to net income
for an indirect method statement of cash flows.
New England Co. had net cash provided by operating activities of $351 ,000; net cash used by investing
activities of $420,000; and cash provided by financing activities of $250,000. New England's cash balance
was $27 ,000 on January 1. During the year, there was a sale of land that resulted in a gain of $25,000 and
proceeds of $40,000 were received from the sale. What was New England's cash balance at the end of the
Choice "c" is correct. New England's cash balance at the end of the year includes the cash balance at the
beginning of the year, the net cash provided by operating activities, the net cash used by investing activities,
and the net cash provided by financing activities ($27,000 + $351,000 - $420,000 + $250,000 = $208,000).
The sale of the land was included in the cash from the investing activities and does not have to be considered
separately. When working this type of question, be sure to distinguish between the net cash used and the net
Paper Co. had net income of $70,000 during the year. Dividend payment was $10,000. The following
information is available:
Mortgage repayment $20,000
Available-for-sale securities purchased 10,000 increase
Bonds payable - issued 50,000 increase
Inventory 40,000 increase
Accounts payable 30,000 decrease
What amount should Paper report as net cash provided by operating activities in its statement of cash flows
for the year under U.S. GAAP?
0 dollars is correct. The operating activities section includes cash flows from working capital (current assets
and current liabilities) and other income statement items. Under the indirect method, net income is adjusted
for non-cash items and increases/decrease in working capital items to arrive at net cash from operating
activities. Increases in current assets and decreases in current liabilities are uses of cash, while decreases in
current assets and increases in current liabilities increase cash.
Net income $70,000
Less: Increase in inventory (40,000)
Less: Decrease in AP (30,000)
Net cash provided by operating activities $ 0
For the year ended December 31, Ion Corp. had cash inflows of $25,000 from the purchases, sales, and
maturities of held-to-maturity securities and $40,000 from the purchases, sales, and maturities of availablefor-
sale securities. What amount of net cash from investing activities should Ion report in its cash flow
Choice "d" is correct. Net cash from investing activities is $65,000 ($25,000 + $40,000) because investing
activities include cash flows from both available-for-sale and held-to-maturity security transactions.
Green Co. had the following equity transactions at December 31:
Cash proceeds from sale of investment in Blue Co.
(carrying value - $60,000) $75,000
Dividends received on Grey Co. stock 10,500
Common stock purchased from Brown Co. 38,000
What amount should Green recognize as net cash from investing activities in its statement of cash flows at December 31 under U.S. GAAP?
Choice "a" is correct. Net cash from investing activities should include the cash received from the sale of the investment in Blue Co. offset by the cash paid to purchase the common stock from Brown Co.:$75,000
Cash proceeds from sale of Blue Co. (38,000)
Cash paid to purchase Brown Co. common stock Net cash received from investing activities $37,000
Tam Co. reported the following items in its year-end financial statements:
Capital expenditures $1,000,000
Capital lease payments 125,000
Income taxes paid 325,000
Dividends paid 200,000
Net interest payments 220,000
What amount should Tam report as supplemental disclosures in its statement of cash flows prepared
Using the indirect method?
c. $1,125 ,000
d. $1,870 ,000
Choice "a" is correct. When the indirect method is used, a supplemental disclosure of cash paid
for interest and income taxes is required. Tam will report total cash paid for interest and income
taxes of $545,000
($325,000 income taxes paid + $220,000 net interest payments).
Under IFRS, interest received during a period is reported on the statement of cash flows in:
a. Operating cash flow only.
b. Investing cash flow only.
c. Operating or investing cash flow.
d. Operating or financing cash flow
Choice "c" is correct. Under IFRS, interest (and dividends) received may be reported in either operating cash
flow or in investing cash flow. Under U.S. GAAP, interest (and dividends) received must be reported
Under IFRS, interest paid during a period is reported on the statement of cash flows in:
a. Operating cash flow only.
b. Financing cash flow only.
c. Operating or investing cash flow.
d. Operating or financing cash flow.
Choice "d" is correct. Under IFRS, interest paid may be reported in either operating cash flow or in financing
cash flow. Under U.S. GAAP, interest paid must be reported only in operating cash flow because interest
expense is reported on the income statement.
Under IFRS, dividends paid during a period are reported on the statement of cash flows in:
a. Operating cash flow only.
b. Financing cash flow only.
c. Operating or investing cash flow.
d. Operating or financing cash flow
Choice "d" is correct. Under IFRS, dividends paid may be reported in either operating cash flow or in
financing cash flow. Under U.S. GAAP, dividends paid must be reported in financing cash flow because
dividends are paid on equity and are not reported on the income statement.
Which of the following would be reported as an investing activity in a company's statement of cash flows?
a. Collection of proceeds from a note payable.
b. Collection of a note receivable from a related party.
c. Collection of an overdue account receivable from a customer.
d. Collection of a tax refund from the government.
Choice "b" is correct. Loans to other entities and the consequent collection of the loans are reflected in the
investing activity section of the cash flow statement.