Quiz 8: Accounting for and Presentation of Stockholders Equity

Common stock-issuance and dividend transactions Altuve Co. was incorporated on January 1, 2016, at which time 250,000 shares of $1 par value common stock were authorized, and 140,000 of these shares were issued for $12 per share. Net income for the year ended December 31, 2016, was $1,200,000. Altuve Co.'s board of directors declared dividends of $2 per share of common stock on December 31, 2016, payable on February 7, 2017. Required: Use the horizontal model (or write the entry) to show the effects of a. The issuance of common stock on January 1, 2016. b. The declaration of dividends on December 31, 2016. c. The payment of dividends on February 7, 2017.

Preferred stock-calculate dividend amounts Laura Marty, Ltd., did not pay dividends on its 9.5%, $100 par value cumulative preferred stock during 2015 or 2016. Since 2009, 175,000 shares of this stock have been outstanding. Laura Marty, Ltd., has been profitable in 2017 and is considering a cash dividend on its common stock that would be payable in December 2017. Required: Calculate the amount of dividends that would have to be paid on the preferred stock before a cash dividend could be paid to the common stockholders.

Effects of a stock split Assume that you own 3,600 shares of $10 par value common stock and the company has a 4-for-1 stock split when the market price per share is $68. Required: a. How many shares of common stock will you own after the stock split? b. What will probably happen to the market price per share of the stock? c. What will probably happen to the par value per share of the stock?

Treasury stock transactions On April 10, 2016, Amelia, Inc., purchased 800 shares of its own common stock in the market for $27 per share. On September 28, 2016, the company sold 500 of these shares in the open market at a price of $31 per share. Required: Use the horizontal model (or write the entry) to show the effects on Amelia, Inc.'s financial statements of a. The purchase of the treasury stock on April 10, 2016. b. The sale of the treasury stock on September 28, 2016.

Review exercise-calculate net income At the beginning of the current fiscal year, the balance sheet of Hughey, Inc., showed stockholders' equity of $260,000. During the year, liabilities increased by $11,000 to $116,000; paid-in capital increased by $20,000 to $90,000; and assets increased by $130,000. Dividends declared and paid during the year were $28,000. Required: Calculate net income or loss for the year. (Hint: Set up the accounting equation for beginning balances, changes during the year, and ending balances; then solve for missing amounts.)

Review exercise-calculate net income At the beginning of the current fiscal year, the balance sheet of Cummings Co. showed liabilities of $876,000. During the year, liabilities decreased by $144,000; assets increased by $308,000; and paid-in capital increased by $40,000 to $760,000. Dividends declared and paid during the year were $248,000. At the end of the year, stockholders' equity totaled $1,516,000. Required: Calculate net income or loss for the year using the same format as shown in Exercise 8.5. Reference of Exercise 8.5 Review exercise-calculate net income At the beginning of the current fiscal year, the balance sheet of Hughey, Inc., showed stockholders' equity of $260,000. During the year, liabilities increased by $11,000 to $116,000; paid-in capital increased by $20,000 to $90,000; and assets increased by $130,000. Dividends declared and paid during the year were $28,000. Required: Calculate net income or loss for the year. (Hint: Set up the accounting equation for beginning balances, changes during the year, and ending balances; then solve for missing amounts.)

Review exercise-calculate retained earnings From the following data, calculate the Retained Earnings balance as of December 31, 2017:

Review exercise-calculate retained earnings From the following data, calculate the Retained Earnings balance as of December 31, 2016:

Common stock balance sheet disclosure The balance sheet caption for common stock is the following: Required: a. Calculate the dollar amount that will be presented opposite this caption. b. Calculate the total amount of a cash dividend of $0.30 per share. c. What accounts for the difference between issued shares and outstanding shares?

Common stock-calculate issue price and dividend amount The balance sheet caption for common stock is the following: Required: a. Calculate the average price at which the shares were issued. b. If these shares had been assigned a stated value of $1 each, show how the caption here would be different. c. If a cash dividend of $1.20 per share were declared, calculate the total amount of cash that would be paid to stockholders. d. What accounts for the difference between issued shares and outstanding shares?

Preferred stock-calculate dividend amounts Calculate the annual cash dividends required to be paid for each of the following preferred stock issues: Required: a. $4.75 cumulative preferred, no par value; 400,000 shares authorized, 325,000 shares issued. (The treasury stock caption of the stockholders' equity section of the balance sheet indicates that 40,600 shares of this preferred stock issue are owned by the company.)b. 5%, $50 par value preferred, 200,000 shares authorized, 172,000 shares issued, and 68,500 shares outstanding. c. 7.4% cumulative preferred, $100 stated value, $104 liquidating value; 80,000 shares authorized, 63,200 shares issued, 57,600 shares outstanding.

Preferred stock-calculate dividend amounts Calculate the cash dividends required to be paid for each of the following preferred stock issues: Required: a. The semiannual dividend on 9% cumulative preferred, $50 par value, 30,000 shares authorized, issued, and outstanding. b. The annual dividend on $6.20 cumulative preferred, 500,000 shares authorized, 160,000 shares issued, 127,400 shares outstanding. Last year's dividend has not been paid. c. The quarterly dividend on 6.5% cumulative preferred, $100 stated value, $103 liquidating value, 200,000 shares authorized, 168,000 shares issued and outstanding. No dividends are in arrears.

Preferred stock-calculate dividend amounts Rosie, Inc., did not pay dividends on its $4.50, $50 par value, cumulative preferred stock during 2015 or 2016, but had met its preferred dividend requirement in all prior years. Since 2011, 42,000 shares of this stock have been outstanding. Rosie, Inc., has been profitable in 2017 and is considering a cash dividend on its common stock that would be payable in December 2017. Required: Calculate the amount of dividends that would have to be paid on the preferred stock before a cash dividend could be paid to the common stockholders.

Preferred stock-calculate dividend amounts Dedrick, Inc., did not pay dividends in 2015 or 2016, even though 70,000 shares of its 8.5%, $50 par value cumulative preferred stock were outstanding during those years. The company has 500,000 shares of $2 par value common stock outstanding. Required: a. Calculate the annual dividend per share obligation on the preferred stock. b. Calculate the amount that would be received by an investor who has owned 1,400 shares of preferred stock and 16,000 shares of common stock since 2014 if a $0.60 per share dividend on the common stock is paid at the end of 2017.

Dividend dates-market price effects O'Garro, Inc., has paid a regular quarterly cash dividend of $0.70 per share for several years. The common stock is publicly traded. On February 21 of the current year, O'Garro's board of directors declared the regular first-quarter dividend of $0.70 per share payable on March 30 to stockholders of record on March 15. Required: As a result of this dividend action, state what you would expect to happen to the market price of the common stock of O'Garro, Inc., on each of the following dates. Explain your answers. a. February 21. b. March 13. c. March 15. d. March 30.

Ex-dividend date-market price effect Find a list of common stock ex-dividend date data. You can go, via Google, to wsj.com. Under the Markets tab, select Market Data; then click on the arrow next to U.S. Stocks to open the pull down menu and select Dividends under the Stocks and Trading Statistics category. Scroll down to the Dividend Declarations Table, which includes the relevant ex-dividend dates. Select several stocks, preferably of large and well-known companies. Go to a stock listing on the ex-dividend date and determine what happened to the market price of a share of stock on that date. Does this price action make sense? Explain your answer.

Requirements for declaring dividends Anglin, Inc., expects to incur a loss for the current year. The chairperson of the board of directors wants to have a cash dividend so that the company's record of having paid a dividend during every year of its existence will continue. What factors will determine whether the board can declare a dividend?

Interpret dividend information from an annual report Refer to the Campbell Soup Company annual report in the appendix. From the table of quarterly financial information and the Selected Financial Data (Five-Year Review-Consolidated), find the information relating to cash dividends on common stock. Required: a. How frequently are cash dividends paid? b. What has been the pattern of the cash dividend amount per share relative to the pattern of earnings per share? c. Calculate the rate of change in the annual dividend per share for each of the years from 2011 through 2014.

Cash dividends versus stock dividends Under what circumstances would you (as an investor) prefer to receive cash dividends rather than stock dividends? Under what circumstances would you prefer stock dividends to cash dividends?

Calculate stock dividend shares and cash dividend amounts Assume that you own 6,000 shares of Briant, Inc.'s common stock and that you currently receive cash dividends of $2.52 per share per year. Required: a. If Briant, Inc., declared a 5% stock dividend, how many shares of common stock would you receive as a dividend? b. Calculate the cash dividend per share amount to be paid after the stock dividend that would result in the same total cash dividend (as was received before the stock dividend). c. If the cash dividend remained at $2.52 per share after the stock dividend, what per share cash dividend amount without a stock dividend would have accomplished the same total cash dividend? d. Why might a company consider having a dividend policy of paying a $0.30 per share cash dividend every year and also issuing a 5% stock dividend every year?

Effects of a stock split Assume that you own 400 shares of $10 par value common stock of a company and the company has a 2-for-1 stock split when the market price per share is $60. Required: a. How many shares of common stock will you own after the stock split? b. What will probably happen to the market price per share of the stock? c. What will probably happen to the par value per share of the stock?

Stock splits versus stock dividends Assume that you own 700 shares of common stock of a company, that you have been receiving cash dividends of $1.89 per share per year, and that the company has a 3-for-2 stock split. Required: a. How many shares of common stock will you own after the stock split? b. What new cash dividend per share amount will result in the same total dividend income as you received before the stock split? c. What stock dividend percentage could have accomplished the same end result as the 3-for-2 stock split?

Common and preferred stock-issuances and dividends Homestead Oil Corp. was incorporated on January 1, 2016, and issued the following stock for cash: 800,000 shares of no-par common stock were authorized; 150,000 shares were issued on January 1, 2016, at $38 per share. 200,000 shares of $100 par value, 6.5% cumulative, preferred stock were authorized, and 90,000 shares were issued on January 1, 2016, at $122 per share. Net income for the years ended December 31, 2016 and 2017 was $2,600,000 and $5,600,000, respectively. No dividends were declared or paid during 2016. However, on December 28, 2017, the board of directors of Homestead declared dividends of $3,600,000, payable on February 12, 2018, to holders of record as of January 19, 2018. Required: a. Use the horizontal model (or write the entry) to show the effects of 1. The issuance of common stock and preferred stock on January 1, 2016. 2. The declaration of dividends on December 28, 2017. 3. The payment of dividends on February 12, 2018. b. Of the total amount of dividends declared during 2017, how much will be received by preferred shareholders?

Common and preferred stock-issuances and dividends Permabilt Corp. was incorporated on January 1, 2016, and issued the following stock for cash: 4,000,000 shares of no-par common stock were authorized; 1,750,000 shares were issued on January 1, 2016, at $45 per share. 1,800,000 shares of $100 par value, 7.5% cumulative, preferred stock were authorized, and 840,000 shares were issued on January 1, 2016, at $105 per share. Net income for the years ended December 31, 2016, 2017, and 2018 was $38,000,000, $46,000,000, and $57,000,000, respectively. No dividends were declared or paid during 2016 or 2017. However, on December 17, 2018, the board of directors of Permabilt Corp. declared dividends of $64,000,000, payable on February 9, 2019, to holders of record as of January 4, 2019. Required: a. Use the horizontal model (or write the entry) to show the effects of 1. The issuance of common stock and preferred stock on January 1, 2016. 2. The declaration of dividends on December 17, 2018. 3. The payment of dividends on February 9, 2019. b. Of the total amount of dividends declared during 2018, how much will be received by preferred shareholders?

Treasury stock transactions On May 4, 2016, Docker, Inc., purchased 1,200 shares of its own common stock in the market at a price of $19.25 per share. On September 19, 2016, 700 of these shares were sold in the open market at a price of $20.50 per share. There were 48,200 shares of Docker common stock outstanding prior to the May 4 purchase of treasury stock. A $0.40 per share cash dividend on the common stock was declared and paid on June 15, 2016. Required: Use the horizontal model (or write the entry) to show the effects on Docker's financial statements of a. The purchase of the treasury stock on May 4, 2016. b. The declaration and payment of the cash dividend on June 15, 2016. c. The sale of the treasury stock on September 19, 2016.

Treasury stock transactions On January 1, 2016, Metco, Inc., reported 822,100 shares of $5 par value common stock as being issued and outstanding. On March 15, 2016, Metco, Inc., purchased for its treasury 7,200 shares of its common stock at a price of $74 per share. On August 10, 2016, 2,900 of these treasury shares were sold for $86 per share. Metco's directors declared cash dividends of $3.10 per share during the second quarter and again during the fourth quarter, payable on June 30, 2016, and December 31, 2016, respectively. A 3% stock dividend was issued at the end of the year. There were no other transactions affecting common stock during the year. Required: a. Use the horizontal model (or write the entry) to show the effect of the treasury stock purchase on March 15, 2016. b. Calculate the total amount of the cash dividends paid in the second quarter. c. Use the horizontal model (or write the entry) to show the effect of the sale of the treasury stock on August 10, 2016. d. Calculate the total amount of cash dividends paid in the fourth quarter. e. Calculate the number of shares of stock issued in the stock dividend.

Transaction analysis-various accounts Enter the following column headings across the top of a sheet of paper: Enter the transaction letter in the first column and show the effect (if any) of each of the following transactions on each financial statement category by entering a plus (+) or minus (?) sign and the amount in the appropriate column. Do not show items that affect net income in the retained earnings column. You may also write the entries to record each transaction. a. Sold 8,200 shares of $50 par value 7% preferred stock at par. b. Declared the annual dividend on the preferred stock. c. Purchased 1,300 shares of preferred stock for the treasury at $54 per share. d. Issued 4,000 shares of $1 par value common stock in exchange for land valued at $226,000. e. Sold 600 shares of the treasury stock purchased in transaction c for $58 per share. f. Split the common stock 2 for 1.

Transaction analysis-various accounts Enter the following column headings across the top of a sheet of paper: Enter the transaction letter in the first column and show the effect (if any) of each of the following transactions on each financial statement category by entering a plus (+) or minus (?) sign and the amount in the appropriate column. Do not show items that affect net income in the retained earnings column. You may also write the entries to record these transactions. You should assume that the transactions occurred in the same chronological sequence as listed here: a. Sold 2,700 shares of $50 par value preferred stock at $53.50 per share. b. Declared the annual cash dividend of $3.70 per share on common stock. There were 7,300 shares of $1 par value common stock issued and outstanding throughout the year. c. Issued 5,000 shares of $50 par value preferred stock in exchange for a building when the market price of preferred stock was $53 per share. d. Purchased 1,400 shares of preferred stock for the treasury at a price of $56 per share. e. Sold 500 shares of the preferred stock held in treasury (see d ) for $57 per share. f. Declared and issued a 15% stock dividend on the $1 par value common stock when the market price per share was $36.

Transaction analysis-various accounts Enter the following column headings across the top of a sheet of paper: Enter the transaction letter in the first column and show the effect (if any) of each of the following transactions on each financial statement category by entering a plus (+) or minus (?) sign and the amount in the appropriate column. Do not show items that affect net income in the retained earnings column. You may also write the entries to record these transactions. You should assume that the transactions occurred in this chronological sequence and that 80,000 shares of previously issued common stock remain outstanding. (Hint: Remember to consider appropriate effects of previous transactions.)a. Sold 10,000 previously unissued shares of $1 par value common stock for $18 per share. b. Issued 2,000 shares of previously unissued 8% cumulative preferred stock, $40 par value, in exchange for land and a building appraised at $80,000. c. Declared and paid the annual cash dividend on the preferred stock issued in transaction b. d. Purchased 500 shares of common stock for the treasury at a total cost of $9,500. e. Declared a cash dividend of $0.15 per share on the common stock outstanding. f. Sold 260 shares of the treasury stock purchased in transaction d at a price of $20 per share. g. Declared and issued a 3% stock dividend on the common stock issued when the market value per share of common stock was $21. h. Split the common stock 3 for 1.

Transaction analysis-various accounts Enter the following column headings across the top of a sheet of paper: Enter the transaction letter in the first column and show the effect (if any) of each of the following transactions on each financial statement category by entering a plus (+) or minus (?) sign and the amount in the appropriate column. Do not show items that affect net income in the retained earnings column. You may also write the entries to record these transactions. You should assume that the transactions occurred in the listed chronological sequence and that no stock had been previously issued. (Hint: Remember to consider appropriate effects of previous transactions.)a. Issued 6,000 shares of $100 par value preferred stock at par. b. Issued 7,200 shares of $100 par value preferred stock in exchange for land that had an appraised value of $756,000. c. Issued 68,000 shares of $5 par value common stock for $12 per share. d. Purchased 28,000 shares of common stock for the treasury at $15 per share. e. Sold 18,000 shares of the treasury stock purchased in transaction d for $17 per share. f. Declared a cash dividend of $2.50 per share on the preferred stock outstanding, to be paid early next year. g. Declared and issued a 12% stock dividend on the common stock when the market price per share of common stock was $30.

Comprehensive problem-calculate missing amounts, dividends, total shares, and per share information Francis, Inc., has the following stockholders' equity section in its November 30, 2016, balance sheet: Required: a. Calculate the amount of the total annual dividend requirement on preferred stock. b. Calculate the amount that should be shown on the balance sheet for preferred stock. c. Calculate the number of shares of common stock that are issued and the number of shares of common stock that are outstanding. d. On January 1, 2016, the firm's balance sheet showed common stock of $105,000 and additional paid-in capital on common stock of $234,375. The only transaction affecting these accounts during 2016 was the sale of common stock. Calculate the number of shares that were sold and the selling price per share. e. Describe the transaction that resulted in the additional paid-in capital from treasury stock. f. The retained earnings balance on January 1, 2016, was $45,150. Net income for the past 11 months was $12,000. Preferred stock dividends for all of 2016 have been declared and paid. Calculate the amount of dividends on common stock during the first 11 months of 2016.

Comprehensive problem-calculate missing amounts, issue price, net income, and dividends; interpret stock dividend and split Bacon, Inc., has the following stockholders' equity section in its May 31, 2016, comparative balance sheets: Required: a. Calculate the amount that should be shown on the balance sheet for common stock at May 31, 2016. b. The only transaction affecting additional paid-in capital during the month of May was the sale of additional common stock. At what price per share were the additional shares sold? c. What was the average cost per share of the common stock purchased for the treasury during the month? d. During May, dividends on preferred stock equal to one-half of the 2016 dividend requirement were declared and paid. There were no common dividends declared or paid in May. Calculate net income for May. e. Assume that on June 1 the board of directors declared a cash dividend of $0.30 per share on the outstanding shares of common stock. The dividend will be payable on July 15 to stockholders of record on June 15. 1. Calculate the total amount of the dividend. 2. Explain the impact this action will have on the June 30 balance sheet and on the income statement for June. f. Assume that on June 1 the market value of the common stock was $66 per share and that the board of directors declared a 5% stock dividend on the issued shares of common stock. Use the horizontal model (or write the entry) to show the issuance of the stock dividend. g. Assume that instead of the stock dividend described in f , the board of directors authorized a 2-for-1 stock split on June 1 when the market price of the common stock was $66 per share. 1. What will be the par value, and how many shares of common stock will be authorized after the split? 2. What will be the market price per share of common stock after the split? 3. How many shares of common stock will be in the treasury after the split? h. By how much will total stockholders' equity change as a result of 1. The stock dividend described in part f ? 2. The stock split described in part g ?

Focus company-stockholders' equity disclosures In Exercise 1.1, you were asked to obtain the most recent annual report of a company that you were interested in reviewing throughout this term. Required: Please review the note disclosures provided in your focus company's annual report and identify at least three items being reported as stockholders' equity items. Discuss what you've learned about these items and how they are presented on the balance sheet. Reference Exercise 1.1: Obtain an annual report Throughout this course, you will be asked to relate the material being studied to actual financial statements. After you complete this course, you will be able to use an organization's financial statements to make decisions and informed judgments about that organization. The purpose of this assignment is to provide the experience of obtaining a company's annual report. You may want to refer to the financial statements in the report during the rest of the course. Required: Obtain the most recently issued annual report of a publicly owned manufacturing or merchandising corporation of your choice. Do not select a bank, insurance company, financial institution, or public utility. It would be appropriate to select a firm that you know something about or have an interest in. Type firmname.com or use a search engine to locate your chosen company's website and then scan your firm's home page for information about annual report ordering. If you don't see a direct link to Investor Relations or Investors on the home page, look for links such as Our Company, About Us, or Site Map that may lead you to SEC Filings, Financial Information, or Annual Reports. Most companies allow you to save or print an Adobe Acrobat version of their annual reports.

Analytical case (part 1)-calculate missing stockholders' equity amounts for 2016 (Note: The information presented in this case is also used for Case 8.35. For now you can ignore the 2017 column in the balance sheet; all disclosures presented here relate to the June 30, 2016, balance sheet.) DeZurik Corp. had the following stockholders' equity section in its June 30, 2016, balance sheet (in thousands, except share and per share amounts): Required: a. Calculate the par value per share of preferred stock and determine the preferred stock dividend percentage. b. Calculate the amount that should be shown on the balance sheet for common stock at June 30, 2016. c. What was the average issue price of common stock shown on the June 30, 2016, balance sheet? d. How many shares of treasury stock does DeZurik Corp. own at June 30, 2016? e. Assume that the treasury shares were purchased for $18 per share. Calculate the amount that should be shown on the balance sheet for treasury stock at June 30, 2016. f. Calculate the retained earnings balance at June 30, 2016, after you have completed parts a-e. (Hint: Keep in mind that Treasury Stock is a contra account.)g. (Optional) Assume that the Retained Earnings balance on July 1, 2015, was $19,200 (in thousands) and that net income for the year ended June 30, 2016, was $1,152 (in thousands). The 2016 preferred dividends were paid in full, and no other dividend transactions were recorded during the year. Verify that the amount shown in the solution to part f is correct. (Hint: Prepare a statement of retained earnings or do a T-account analysis to determine the June 30, 2016, balance.)

Analytical case (part 2)-prepare stockholders' equity amounts and disclosures for 2017 using transaction information (Note: You should review the solution to Case 8.34, provided by your instructor, before attempting to complete this case.) The transactions affecting the stockholders' equity accounts of DeZurik Corp. for the year ended June 30, 2017, are summarized here: 1. 320,000 shares of common stock were issued at $14.25 per share. 2. 80,000 shares of treasury (common) stock were sold for $18 per share. 3. Net income for the year was $1,280 (in thousands). 4. The fiscal 2017 preferred dividends were paid in full. Assume that all 96,000 shares were outstanding throughout the year ended June 30, 2017. 5. A cash dividend of $0.20 per share was declared and paid to common stockholders. Assume that transactions 1 and 2 occurred before the dividend was declared. 6. The preferred stock was split 2 for 1 on June 30, 2017. (Note: This transaction had no effect on transaction 4.)Required: a. Calculate the dollar amounts that DeZurik Corp. would report for each stockholders' equity caption on its June 30, 2017, balance sheet after recording the effects of transactions 1-6. Note that total stockholders' equity at June 30, 2017, is provided as a check figure. (Hint: To determine the Retained Earnings balance, begin with the June 30, 2016, balance of $19,920 (in thousands) as determined in Case 8.34, and then make adjustments for the effects of transactions 3-5.)b. Indicate how the stockholders' equity caption details for DeZurik Corp. would change for the June 30, 2017, balance sheet, as compared to the disclosures shown in Case 8.34 for the 2016 balance sheet. c. What was the average issue price of common stock shown on the June 30, 2017, balance sheet? Reference Case 8.34: Analytical case (part 1)-calculate missing stockholders' equity amounts for 2016 (Note: The information presented in this case is also used for Case 8.35. For now you can ignore the 2017 column in the balance sheet; all disclosures presented here relate to the June 30, 2016, balance sheet.) DeZurik Corp. had the following stockholders' equity section in its June 30, 2016, balance sheet (in thousands, except share and per share amounts): Required: a. Calculate the par value per share of preferred stock and determine the preferred stock dividend percentage. b. Calculate the amount that should be shown on the balance sheet for common stock at June 30, 2016. c. What was the average issue price of common stock shown on the June 30, 2016, balance sheet? d. How many shares of treasury stock does DeZurik Corp. own at June 30, 2016? e. Assume that the treasury shares were purchased for $18 per share. Calculate the amount that should be shown on the balance sheet for treasury stock at June 30, 2016. f. Calculate the retained earnings balance at June 30, 2016, after you have completed parts a-e. (Hint: Keep in mind that Treasury Stock is a contra account.)g. (Optional) Assume that the Retained Earnings balance on July 1, 2015, was $19,200 (in thousands) and that net income for the year ended June 30, 2016, was $1,152 (in thousands). The 2016 preferred dividends were paid in full, and no other dividend transactions were recorded during the year. Verify that the amount shown in the solution to part f is correct. (Hint: Prepare a statement of retained earnings or do a T-account analysis to determine the June 30, 2016, balance.)

Capstone analytical review of Chapters 6-8. Analyzing capital leases, notes payable, preferred stock, and common stock (Note: Please refer to Case 4.30 in Chapter 4 for the financial statement data needed for the analysis of this case. You should also review the solution to Case 4.30, provided by your instructor, before attempting to complete this case.) Your conversation with Mr. Gerrard, which took place in February 2017 (see Case 6.35), continued as follows: Mr. Gerrard: I've been talking with my accountant about our capital expansion needs, which will be considerable during the next couple of years. To stay in a strong competitive position, we're constantly buying new pieces of earthmoving equipment and replacing machinery that has become obsolete. What it all comes down to is financing, and it's not easy to raise $20 million to $40 million all at once. There are a number of options, including dealer financing, but the interest rates offered by banks are usually lower. Your reply: From reviewing your balance sheet, I can see that you've got a lot of notes payable already. How is your relationship with your bank? Mr. Gerrard: Actually we use several banks and we have an excellent credit history, so getting the money is not a major problem. The problem is that we already owe more than $100 million and I don't want to get overextended. Your reply: Have you considered long-term leases? Mr. Gerrard: Yes. This is essentially how dealer financing works. Usually it is arranged as a lease with an option to buy the equipment after a number of years. We've been actively looking into this with our Cat dealer for several scrapers that we need to put on a big job immediately. I can show you one of the contracts involved. Your reply: OK, I'll have a look at the contract, but this sounds like a long-term capital lease. Mr. Gerrard: Yes, I think that's what my accountant called it. What matters most to me is that we get the equipment in place ASAP; but if you could explain what the accounting implications would be of entering into these types of arrangements, that might put me at ease about it. Your reply: No problem; will do. It would impact both your balance sheet and income statement, but in most respects a long-term capital lease is treated very much like a long-term note payable with a bank. I'll give you a memo about it. But what about looking into other sources of equity financing? Have you considered any of these options? Mr. Gerrard: We're a family business and want to keep it that way. Our shares are publicly traded, but we're owned mostly by family members and employees. We've got a lot of retained earnings, but that's not the same thing as cash, you know. Should we be issuing bonds? Your reply: Issuing bonds is possible, but I was thinking more on the lines of preferred stock. Are you familiar with this option? Mr. Gerrard: Not really. Isn't preferred stock a lot like bonds payable? Your reply: Maybe this is something else I should include in my memo: an explanation of the differences between common stock, preferred stock, and bonds payable. Mr. Gerrard: Yes, please do. Required: a. When discussing capital leases with Mr. Gerrard, you commented, "It would impact both your balance sheet and income statement, but in most respects a long-term capital lease is treated very much like a long-term note payable with a bank." Explain the accounting treatment of capital leases as compared to the accounting treatment of notes payable in terms that a nonaccountant could easily understand. Include in your answer both the balance sheet and income statement effects of capital leases. (Note: You do not need to make reference to the four criteria for capitalizing a lease.)b. Assume you have reviewed the contract Mr. Gerrard provided concerning the dealer financing agreement for the purchase of two new scrapers. You have determined that the lease agreement would qualify as a capital lease. The present value of the lease payments would be $4 million. Use the horizontal model, or write the journal entry, to show Mr. Gerrard how this lease would affect the financial statements of Gerrard Construction Co. c. Explain what Mr. Gerrard meant by this statement: "We've got a lot of retained earnings, but that's not the same thing as cash, you know." Review the balance sheet at December 31, 2016, provided in Case 4.30. In which assets are most of the company's retained earnings invested? d. Explain to Mr. Gerrard what the similarities and differences are between bonds payable, preferred stock, and common stock. e. Why would you recommend to Mr. Gerrard that his company consider issuing $20 million to $40 million of preferred stock rather than bonds payable? (Hint: Review the company's balance sheet provided in Case 4.30 in the context of your present conversation with Mr. Gerrard. )