ACCT 3621 Intermediate Accounting II

Correct Answer

B. The market price of an unrestricted share of the same stock

Explanation

The compensation value of RSUs is typically calculated based on the market price of the company’s common stock at the grant date. This reflects the fair value of the shares that will ultimately be delivered to the employee, making it the most accurate representation of compensation cost. The market price is used consistently under accounting standards like IFRS and US GAAP.

Why other options are wrong

A. The book value of an unrestricted share of the same stock

Book value represents the accounting value of equity per share but does not reflect the current market perception or trading price of the shares. It’s not suitable for valuing stock-based compensation because it can be outdated or irrelevant to actual market conditions.

C. The historical cost of the stock

Historical cost is irrelevant for RSU valuation. Compensation should reflect the current fair value at the time of grant, not what the company originally paid or recorded for the stock. Using historical cost would misrepresent the real economic value of the award.

D. The par value of the stock

Par value is a nominal figure often set at a very low amount and has little to no relation to the market value of the stock. It’s used primarily for legal or accounting purposes and does not provide a realistic measure for compensation valuation.

Correct Answer

A. $10 million

Explanation

When stock options are exercised, shareholders' equity increases by the amount the company receives for the options exercised. In this case, the exercise price for the options is $10 per share, and there are 1 million options. The total amount received by the company for these options is 1 million * $10 = $10 million. This amount is added to shareholders' equity. The market price of $20 does not affect the increase in equity for this calculation; it is the exercise price that determines the equity increase.

Why other options are wrong

B. $20 million

This is incorrect because the market price of $20 does not affect the increase in equity from the exercise of stock options. The increase is based on the exercise price of $10 per option, not the market price.

C. $30 million

This is incorrect because, similarly to the previous answer, the increase in equity is based on the exercise price, not the difference between the exercise price and market price. The equity increase will not be the $10 difference between the exercise price and the market price times the number of shares.

D. $40 million

This is incorrect for the same reasons as the others. The total increase in equity is determined by the exercise price, not the market price, and multiplying the market price by the number of options would overstate the increase.

Correct Answer

B. Debit to Cash and a credit to Common Stock.

Explanation

When an owner makes an investment by contributing cash into the business in exchange for shares of stock, the transaction is recorded by debiting (increasing) cash and crediting (increasing) common stock. This reflects the receipt of cash and the issuance of stock to the investor. The cash received increases the company's liquidity, and the common stock account represents the ownership interest given to the investor in return for the cash investment.

Why other options are wrong

A. Debit to Common Stock and a credit to Cash.

This is incorrect because the cash account should be debited (increased), not the common stock account. Common stock is credited because it's the account that reflects the issuance of shares to the investor.

C. Debit to Cash and a credit to Retained Earnings.

This is incorrect because retained earnings represent accumulated profits and not capital contributions. When cash is invested, it should be recorded as an increase in common stock, not retained earnings.

D. Debit to Cash and a credit to Stockholder Revenue.

This is incorrect because there is no account called "Stockholder Revenue." Stockholder equity is increased by issuing common stock, not through a revenue account.

Correct Answer

B. $1.67

Explanation

Diluted earnings per share (EPS) accounts for the potential dilution that could occur if stock options are exercised and converted into additional shares. The formula to calculate diluted EPS is:

Diluted EPS = $\frac{Net Income}{Weighted Average Shares Outs\tan ding+Additional Shares from Options}$

Given:

Net income = $2,000,000

Shares outstanding = 1,000,000

Additional shares from stock options = 200,000

The total shares outstanding after accounting for the potential dilution would be:

1,000,000 + 200,000 = 1,200,000 shares Now, calculate the diluted EPS:

Diluted EPS = $\frac{2,000,000}{1,200,000}$ = 1.67

Why other options are wrong

A. $2.00

This is incorrect because it represents the basic EPS without considering the potential dilution from stock options. The basic EPS is calculated as:

Basic EPS= $\frac{2,000,000}{1,000,000}$ = 2.0

Since the options could potentially convert into additional shares, the diluted EPS is lower than the basic EPS.

C. $1.50

This is incorrect because the diluted EPS is calculated as $1.67, not $1.50. The dilution effect of the 200,000 additional shares is not significant enough to reduce the EPS to $1.50.

D. $1.80

This is incorrect because, based on the information provided, the correct diluted EPS is $1.67, not $1.80. The dilution caused by the 200,000 potential new shares does not lead to a higher EPS of $1.80.

Correct Answer

A) It allows them to purchase additional shares to prevent dilution of their ownership.

Explanation

The preemptive right gives existing shareholders the opportunity to purchase additional shares before the company offers them to the general public. This protects shareholders from dilution of their ownership percentage in the company, ensuring that their stake in the company remains proportionate to their original investment. Without this right, shareholders could see their influence over corporate decisions and share of profits decrease as new shares are issued.

Why other options are wrong

B) It guarantees them a fixed dividend rate regardless of company performance.

This is incorrect because the preemptive right does not relate to guaranteeing a fixed dividend rate. Dividends are typically declared based on the company's performance and discretion, not based on shareholders’ ability to purchase additional shares.

C) It provides them with exclusive voting rights over new shareholders.

This is incorrect because the preemptive right does not confer voting rights specifically over new shareholders. Instead, it allows existing shareholders to maintain their proportionate ownership by purchasing new shares before they are offered to others.

D) It ensures they receive a larger share of the company's profits.

This is incorrect because the preemptive right does not ensure shareholders a larger share of profits. It only allows them to maintain their ownership percentage and thus their share of profits, but it does not increase their share of profits in absolute terms.

Correct Answer

C. Basic earnings per share may increase or decrease depending on the number of shares issued versus repurchased

Explanation

The effect on basic earnings per share (EPS) depends on the net change in the number of shares outstanding after both issuing new shares and repurchasing treasury stock. If more shares are issued than repurchased, the total number of shares outstanding increases, likely causing a decrease in EPS. If more treasury stock is repurchased than shares issued, the number of shares outstanding decreases, which could increase EPS.

Why other options are wrong

A. Basic earnings per share will definitely increase

This is incorrect because repurchasing treasury stock typically reduces the number of shares outstanding, which could increase EPS only if the number of shares issued is smaller than the number repurchased. However, if more shares are issued, the increase in outstanding shares could decrease EPS.

B. Basic earnings per share will definitely decrease

This is incorrect because the effect on EPS depends on the balance between the number of shares issued and repurchased. If more treasury stock is repurchased than new shares are issued, EPS could increase, not decrease.

D. Basic earnings per share will remain unchanged

This is incorrect because issuing new shares and repurchasing treasury stock usually affects the number of shares outstanding, which in turn affects basic EPS. It is unlikely that these two actions will exactly cancel each other out, leaving EPS unchanged.

Correct Answer

C. Basic earnings per share may increase or decrease depending on the number of shares issued versus repurchased

Explanation

The effect on basic earnings per share (EPS) depends on the net change in the number of shares outstanding after both issuing new shares and repurchasing treasury stock. If more shares are issued than repurchased, the total number of shares outstanding increases, likely causing a decrease in EPS. If more treasury stock is repurchased than shares issued, the number of shares outstanding decreases, which could increase EPS.

Why other options are wrong

A. Basic earnings per share will definitely increase

This is incorrect because repurchasing treasury stock typically reduces the number of shares outstanding, which could increase EPS only if the number of shares issued is smaller than the number repurchased. However, if more shares are issued, the increase in outstanding shares could decrease EPS.

B. Basic earnings per share will definitely decrease

This is incorrect because the effect on EPS depends on the balance between the number of shares issued and repurchased. If more treasury stock is repurchased than new shares are issued, EPS could increase, not decrease.

D. Basic earnings per share will remain unchanged

This is incorrect because issuing new shares and repurchasing treasury stock usually affects the number of shares outstanding, which in turn affects basic EPS. It is unlikely that these two actions will exactly cancel each other out, leaving EPS unchanged.

Correct Answer

C) It shows the difference between the retirement price and the par value of the shares.

Explanation

When a company retires shares, the amount paid to retire the shares that exceeds the par value is recorded as a reduction in additional paid-in capital (APIC). The APIC account reflects the difference between the retirement price (the amount paid to retire the shares) and the par value of the shares. This is important because it provides transparency in the company's equity accounts and ensures that the financial statements accurately reflect the impact of share repurchases.

Why other options are wrong

A) It reflects the company's profitability.

This is incorrect because the increase in additional paid-in capital when shares are retired is not a direct reflection of profitability. It reflects the accounting treatment of the shares and their repurchase cost, not how well the company is performing financially.

B) It indicates the amount of cash available for dividends.

This is incorrect because the amount in additional paid-in capital does not indicate the cash available for dividends. The ability to pay dividends is determined by the company's retained earnings and cash flow, not by the increase or decrease in APIC.

D) It affects the company's total liabilities.

This is incorrect because the retirement of shares does not directly affect the company’s total liabilities. The transaction impacts equity accounts (such as additional paid-in capital) but does not directly impact liabilities, which are obligations to external parties.

Correct Answer

A. To maintain a proportional ownership interest in the corporation

Explanation

The primary purpose of the preemptive right is to allow shareholders to maintain their proportional ownership interest in the corporation when new shares are issued. This right gives existing shareholders the first opportunity to purchase additional shares before the company offers them to other investors, thus preventing dilution of their ownership stake in the company.

Why other options are wrong

B. To influence corporate policy through voting

While shareholders do have voting rights, the preemptive right is specifically related to the ability to maintain ownership by purchasing additional shares, not about influencing corporate policy through voting.

C. To ensure a minimum dividend payout

The preemptive right does not guarantee a minimum dividend payout. It is concerned with maintaining ownership proportions when new shares are issued, not with guaranteeing dividends.

D. To receive priority in asset distribution during liquidation

The preemptive right does not provide priority in asset distribution during liquidation. Priority in liquidation is typically determined by the seniority of the claims (e.g., creditors, preferred shareholders). The preemptive right is specifically about maintaining ownership interest, not liquidation preferences.