ACCT 3621 Intermediate Accounting II

Correct Answer

B) Preferred dividends are paid before common dividends.

Explanation

When calculating earnings available to common shareholders, preferred dividends are deducted from net income because preferred shareholders have a priority claim on dividends over common shareholders. Since preferred dividends must be paid out before any dividends can be distributed to common shareholders, they are subtracted from net income to determine the portion of earnings that is available to common shareholders. This ensures that the calculation reflects only the earnings that are attributable to the common shareholders.

Why other options are wrong

A) Preferred dividends are not considered an expense.

While preferred dividends are not considered an expense in the income statement, they are still subtracted from net income when calculating earnings available to common shareholders. They represent a distribution of profits rather than a business expense.

C) Preferred dividends are included in operating income.

This is incorrect because preferred dividends are not part of operating income. They are a distribution of profit after operating income has been determined, so they are deducted from net income rather than operating income.

D) Preferred dividends affect the cash flow of the company.

This is not the reason why preferred dividends are deducted when calculating earnings available to common shareholders. While preferred dividends do affect cash flow, the deduction from net income reflects the priority claim of preferred shareholders on dividends, not the cash flow impact.

Correct Answer

C. relative fair value

Explanation

When a corporation issues different types of securities (such as common stock and bonds) in a combined offering, it allocates the total proceeds based on the relative fair value of each security. This method ensures that each component is recognized appropriately in the financial statements according to its fair market value proportion of the entire transaction.

Why other options are wrong

A. stated value

This is incorrect because stated value is often an arbitrary amount assigned to stock and does not reflect the actual worth or market value of the security. It is primarily used for legal or accounting purposes, not for allocating sale proceeds.

B. par value

This is incorrect because par value is usually a nominal amount assigned to shares and bears little relation to their actual market value. Using par value to allocate proceeds would not fairly represent the economic substance of the transaction.

D. market value

This is incorrect because while market value is relevant, the proper method is to allocate proceeds based on relative fair value, which compares the market values proportionally rather than just assigning full market value independently to each security.

Correct Answer

A. It decreases the number of shares outstanding, potentially increasing EPS.

Explanation

When a company purchases its own stock and holds it as treasury stock, the number of shares outstanding decreases. This reduction in outstanding shares can increase the basic earnings per share (EPS), as the company's net income is now distributed over a smaller number of shares. Basic EPS is calculated by dividing net income by the weighted average shares outstanding, so a decrease in outstanding shares results in a higher EPS, assuming net income remains the same. This principle is related to the concept of capital structure, specifically the impact of treasury stock transactions on the total number of shares outstanding.

Why other options are wrong

B. It has no effect on EPS.

This is incorrect because purchasing treasury stock does affect EPS by reducing the number of shares outstanding, which can lead to an increase in EPS.

C. It increases the number of shares outstanding, decreasing EPS.

This is incorrect because purchasing treasury stock actually decreases the number of shares outstanding, not increases them. A reduction in shares outstanding can increase EPS, not decrease it.

D. It only affects retained earnings.

This is incorrect because while purchasing treasury stock does reduce retained earnings, it also directly impacts the number of shares outstanding, which in turn can affect EPS. Therefore, it affects more than just retained earnings.

Correct Answer

B) 2,200,000 shares.

Explanation

The stock dividend increases the number of shares outstanding by 10%. Therefore, after the 10% stock dividend, the company will have 1,100,000 shares (1,000,000 * 1.10). Following the 2-for-1 stock split, the total number of shares will double, resulting in 2,200,000 shares. The weighted-average shares outstanding for the next reporting period would reflect this increase.

Why other options are wrong

A) 1,100,000 shares.

This is incorrect because, while the stock dividend increases the shares to 1,100,000, the subsequent 2-for-1 stock split will double the number of shares to 2,200,000.

C) 1,000,000 shares.

This is incorrect because the stock dividend and stock split both increase the number of shares outstanding, so the weighted-average shares outstanding should reflect these changes.

D) 1,200,000 shares.

This is incorrect because after the stock dividend, the number of shares is 1,100,000. The stock split then doubles that number to 2,200,000 shares, not 1,200,000.

Correct Answer

B) $1,250 as an expense each year for four years.

Explanation

When stock options are granted, the company must recognize compensation expenses based on the fair value of the options over the vesting period. In this case, the total fair value of the 1,000 options is $5 * 1,000 = $5,000. Since the options vest over four years, the company will recognize an expense of $1,250 each year ($5,000 ÷ 4) during the vesting period.

Why other options are wrong

A) $5,000 as an expense in the first year.

This is incorrect because the expense is spread over the vesting period, not recorded all in the first year.

C) $5,000 as an expense at the end of the four years.

This is incorrect because the expense must be recognized over the vesting period rather than all at once at the end.

D) $0 until the options are exercised.

This is incorrect because the expense is recognized over the vesting period, not when the options are exercised.

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.

Correct Answer

A. Recognize the total fair value of the options granted as expense

Explanation

When a company does not estimate forfeitures, it is required to recognize the total fair value of the share-based compensation granted as an expense, regardless of whether some options are ultimately forfeited. This treatment aligns with accounting standards (such as ASC 718) which state that the total value should be recognized and adjusted for actual forfeitures as they occur. By recognizing the entire fair value at the time of grant, the company ensures that compensation expense reflects the total value of options granted to employees, even if some are forfeited in the future.

Why other options are wrong

B. Only expense the options that are exercised

This is incorrect because share-based compensation expense is recognized over the vesting period, based on the total fair value of the options granted, regardless of whether the options are exercised. This treatment ensures that the company matches the expense with the services rendered during the vesting period.

C. Expense the options based on historical forfeiture rates

While some companies may use historical forfeiture rates as a basis for estimating forfeitures, the correct treatment when forfeitures are not estimated is to expense the total fair value of the options granted. The expense is adjusted for actual forfeitures as they occur.

D. Record no expense until the options are exercised

This is incorrect because share-based compensation expense is recognized over the vesting period, not when the options are exercised. Waiting until the options are exercised would delay the recognition of the compensation expense and would not align with the matching principle in accounting.

Correct Answer

B. They decrease the number of shares outstanding, thus increasing EPS.

Explanation

Treasury stock consists of shares that were previously issued and later repurchased by the company. These shares are not considered outstanding, so when a company buys back its own shares, the total number of outstanding shares decreases. Since basic earnings per share (EPS) is calculated by dividing net income by the weighted average number of shares outstanding, a lower share count leads to a higher EPS, assuming net income remains unchanged.

Why other options are wrong

A. They increase the number of shares outstanding, thus lowering EPS.

This is incorrect because treasury stock is repurchased by the company and removed from the pool of outstanding shares. Therefore, it decreases—not increases—the number of shares outstanding. An increase in shares outstanding would lower EPS, but treasury stock causes the opposite effect.

C. They have no effect on the number of shares outstanding.

This is incorrect because treasury stock directly affects the number of shares outstanding. Shares held in treasury are excluded from this count, so repurchasing stock reduces the denominator in the EPS calculation and impacts the final EPS figure.

D. They only affect diluted EPS, not basic EPS.

This is incorrect because treasury stock affects both basic and diluted EPS. While diluted EPS accounts for potential shares from convertible securities or options, basic EPS is impacted by the actual number of shares outstanding—which is reduced when shares are repurchased and held as treasury stock.

Correct Answer

A. $100,000 per year.

Explanation

When stock options vest over a period of time, the total fair value of the options is allocated evenly over the vesting period as compensation expense. In this case, the total fair value is $300,000 and the vesting period is 3 years. Therefore, the company should recognize $300,000 ÷ 3 = $100,000 per year as compensation expense.

Why other options are wrong

B. $150,000 per year

This is incorrect because it would result in a total expense of $450,000 over three years, which exceeds the actual fair value of the options granted. The expense must match the total fair value determined at the grant date.

C. $300,000 per year

This is incorrect because it would recognize the entire compensation expense in the first year instead of spreading it evenly over the 3-year vesting period. The correct accounting treatment is to allocate the cost evenly unless otherwise specified.

D. $75,000 per year

This is incorrect because it would only total $225,000 over three years, which underreports the total fair value of the options and violates proper accounting standards for share-based compensation.