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Unformatted text preview: 12-1Odd-numbered SolutionsCHAPTER 12SHAREHOLDERS' EQUITY: CAPITAL CONTRIBUTIONS,DISTRIBUTIONS, AND EARNINGSQuestions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions12.1See the text or the glossary at the end of the book.12.3The accounting for each of these transactions potentially involves transfersbetween contributed capital and retained earnings accounts and clouds thedistinction between capital transactions and operating transactions. Themarket value method of accounting for stock options results in a reduction innet income and retained earnings and an increase in contributed capital.The accounting for stock dividends results in a reduction in retained earningsand an increased in contributed capital. The purchase of treasury stockrepresents a reduction in both contributed capital and accumulatedearnings. The reissuance of treasury stock at a “loss” may result in a debitto both contributed capital and retained earnings. Thus, the Common Stockand Additional Paid-in Capital accounts do not reflect just capitaltransactions and Retained Earnings does not reflect just operatingtransactions.12.5All three items permit their holder to acquire shares of common stock at aset price. Their values depend on the difference between the market priceand the exercise price on the exercise date and the length of the exerciseperiod. Firms grant stock options to employees, grant stock rights tocurrent shareholders and either sell stock warrants on the open market orattach them to a debt or preferred stock issue. The issuance of stockoptions and stock rights does not result in an immediate cash inflow,whereas the issuance of a stock warrant usually does. Accountantsamortize the cost of stock options to expense over the expected period ofbenefit. Accountants credit a Stock Warrant account if the value of thestock warrant is objectively measurable. At the time of exercise of all theseitems, the accountant records the cash proceeds as a capital contribution.12.7The theoretical rationale is matching expenses of employee compensationwith the benefit received in the form of higher revenues from employees’services.Odd-numbered Solutions12-212.9The managers of a firm have knowledge of the plans and risks of the firmthat external investors may not possess. Although laws prevent firms fromtaking advantage of this “inside information,” inclusion of gains fromtreasury stock transactions in net income might motivate firms to buy andsell treasury stock to improve reported earnings. Excluding these gains fromnet income removes this incentive. Also, the accounting for the acquisitionof treasury stock (that is, a reduction from total shareholders’ equity) hasthe same effect on shareholders’ equity as a retirement of the capital stock....
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- Fall '07
- Corporate Finance, ........., Additional Paid-in Capital