ACCT 3621 Intermediate Accounting II

Correct Answer

B) Retained earnings remain unchanged.

Explanation

When a company issues shares, the transaction typically increases its paid-in capital but does not affect retained earnings. Similarly, when shares are subsequently retired, the company reduces its outstanding shares and corresponding paid-in capital, but there is no direct impact on retained earnings. Retained earnings represent accumulated profits that have not been distributed to shareholders as dividends, so transactions involving shares, such as issuance or retirement, do not affect the retained earnings balance.

Why other options are wrong

A) Retained earnings are increased.

This is incorrect because issuing or retiring shares does not directly affect retained earnings. Retained earnings are only affected by net income or dividends paid, not by the issuance or retirement of shares.

C) Retained earnings are decreased.

This is incorrect because retiring shares typically reduces paid-in capital and stockholders' equity, but does not affect retained earnings.

D) Retained earnings are eliminated.

This is incorrect because issuing or retiring shares does not eliminate retained earnings. Retained earnings remain intact unless affected by net income or dividend distribution.

Correct Answer

C. EPS will decrease due to higher expenses

Explanation

When a company revises its estimate of share-based compensation expense upward, the total compensation expense increases. This increase in expenses reduces the company's net income for the reporting period, leading to a decrease in earnings per share (EPS). Since EPS is calculated by dividing net income by the weighted average number of shares outstanding, any increase in expenses (which reduces net income) will lower the EPS.

Why other options are wrong

A. EPS will increase due to lower expenses

This is incorrect because revising the share-based compensation expense upward increases the expenses, not reduces them. Therefore, EPS will not increase due to lower expenses.

B. EPS will remain unchanged as it does not affect net income

This is incorrect because an upward revision in compensation expense directly affects net income, which in turn affects EPS. Therefore, EPS will not remain unchanged.

D. EPS will increase due to additional revenue

This is incorrect because revising the share-based compensation expense does not generate additional revenue. Instead, it increases expenses, which leads to a reduction in net income and consequently decreases EPS.

Correct Answer

C) Publicly traded corporations.

Explanation

Publicly traded corporations are required by financial regulations (such as the SEC in the U.S.) to report earnings per share (EPS). This requirement ensures that investors have clear information about the company's profitability on a per-share basis. Private companies, on the other hand, do not have the same requirement, as they do not have public shareholders.

Why other options are wrong

A) Private companies

Private companies are not required to report EPS, as they do not have publicly traded shares and are not under the same financial reporting regulations as public companies.

B) Companies with complex capital structures

This is incorrect because while companies with complex capital structures may have more detailed EPS disclosures (e.g., diluted EPS), the requirement to report EPS is specifically for publicly traded corporations, not only those with complex structures.

D) Medium-sized and large corporations

This is incorrect because the reporting of EPS is not based on the size of the company, but rather on whether it is publicly traded.

Correct Answer

A. Debit Cash, Credit Common Stock

Explanation

When stock is issued for cash, the company receives cash, which is debited to the Cash account. At the same time, the Common Stock account is credited for the par value of the issued stock. This transaction reflects the increase in both assets (cash) and stockholders' equity (common stock) due to the issuance of shares.

Why other options are wrong

B. Debit Common Stock, Credit Cash

This is incorrect because the company would debit cash to record the receipt of funds, not common stock. The common stock account is credited for the par value of the stock issued, not debited.

C. Debit Additional Paid-In Capital, Credit Common Stock

This is incorrect as the entry to record stock issuance focuses on the par value of the stock, which is credited to the Common Stock account. Additional Paid-In Capital is used only if the stock is issued above its par value, and that would be an additional transaction after the basic stock issuance.

D. Debit Retained Earnings, Credit Common Stock

This is incorrect because retained earnings are used to record accumulated profits or losses, not for issuing new stock. The proper entry for stock issuance does not involve retained earnings.

Correct Answer

B) Earnings decrease due to the expense recognized for the options.

Explanation

When a company issues stock options to employees, it recognizes a compensation expense over the vesting period. This expense reduces earnings during the period in which the options are vested. However, when the options are exercised, no additional expense is recorded. The initial recognition of the expense (in the vesting period) affects earnings, and if the options are exercised, there is no further impact on the earnings, but the expense has already been accounted for.

Why other options are wrong

A) Earnings increase due to higher revenue.

This is incorrect because the issuance of stock options does not directly result in higher revenue. The impact is on compensation expenses, not revenue.

C) Earnings remain unchanged as options do not affect cash flow.

While stock options may not directly affect cash flow, they do affect earnings because of the recognition of compensation expenses related to the options.

D) Earnings decrease only if the options are not exercised.

This is incorrect because the expense related to the stock options is recognized during the vesting period, regardless of whether the options are exercised or not. The exercise of the options itself does not affect earnings.

Correct Answer

B. Additional paid-in capital is decreased.

Explanation

When a company acquires and retires its own stock, it reduces its outstanding shares, and the accounting entry typically includes a decrease in Additional Paid-In Capital (APIC). In this case, Winn, Inc. issued stock for $35 per share, which means the APIC was originally recorded as the amount above the par value of $1 per share (i.e., $34 per share). When shares are repurchased for $30 per share, the repurchased stock is removed from both the common stock and APIC accounts. The difference between the original issue price and the repurchase price reduces APIC. This action does not directly affect net income or retained earnings but adjusts the equity section of the balance sheet.

Why other options are wrong

A. 2021 net income is decreased.

This is incorrect because the acquisition and retirement of stock does not directly affect net income. Stock repurchases are recorded in the equity section of the balance sheet, and the transaction does not involve an expense or revenue item that would impact the income statement.

C. 2021 net income is increased.

This is incorrect because the repurchase and retirement of shares does not affect net income. It is an equity transaction, not a revenue or expense transaction, so it does not impact net income.

D. Retained earnings are increased.

This is incorrect because the acquisition and retirement of stock typically results in a decrease in retained earnings if the repurchase price is higher than the stock's par value or original issue price. Retained earnings would only increase if the company repurchased stock at a price lower than the par value or original issue price, which is not the case here.

Correct Answer

C. Relative market values

Explanation

When a company sells multiple securities for a single price and the total selling price differs from the sum of the market prices, the method used to allocate the cash received is based on relative market values. The cash is allocated among the securities in proportion to their respective market values at the time of the sale. This ensures that the allocation is fair and reflects the relative worth of each security.

Why other options are wrong

A. Par amounts

Allocating based on par values is not appropriate for securities that have market values different from their par values. Par value is generally an arbitrary value assigned to stock, and it does not reflect the true economic value of the securities. Using par values would distort the allocation.

B. Relative book values

Relative book values could be used in certain situations, but they are not the standard method for allocating cash received from the sale of multiple securities. The relative market value method is preferred because it reflects the actual current market prices of the securities at the time of sale.

D. The earnings per share

Earnings per share (EPS) is a financial metric used to calculate the profitability of a company on a per-share basis and is not used in allocating cash when selling multiple securities. This option is unrelated to the allocation process for securities sold for a single price.

Correct Answer

B) It reallocates retained earnings to paid-in capital; retained earnings remain unchanged.

Explanation

A stock dividend involves distributing additional shares of stock to shareholders based on their existing holdings, but no cash is involved. When a stock dividend is declared, retained earnings are reduced because the value of the dividend is transferred to the paid-in capital account, which reflects the additional shares issued. The total value of equity remains unchanged because the amount in retained earnings is simply reallocated to the paid-in capital account.

Why other options are wrong

A) It increases liabilities; it does not affect retained earnings.

This is incorrect because a stock dividend does not create a liability; it merely reallocates part of retained earnings to paid-in capital.

C) It decreases total equity; retained earnings are reduced.

This is incorrect because a stock dividend does not reduce total equity. Instead, it reallocates the amount in retained earnings to paid-in capital, so the overall equity remains the same.

D) It increases total assets; retained earnings are unaffected.

This is incorrect because a stock dividend does not increase assets. No cash or other assets are involved in the transaction—just a reallocation between retained earnings and paid-in capital.

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.