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12-1 Solutions CHAPTER 12 SHAREHOLDERS' EQUITY: CAPITAL CONTRIBUTIONS, DISTRIBUTIONS, AND EARNINGS Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 12.1 See the text or the glossary at the end of the book. 12.2 The common shareholders would not likely receive an amount equal to the amounts in the common shareholders’ equity accounts. The amounts in these accounts reflect acquisition cost valuations for assets. The firm might sell assets for more or less than their book values, with the common shareholders thereby receiving more or less than the amount in the common shareholders’ equity accounts. Furthermore, the bankruptcy and liquidation process requires legal and other costs not now reflected on the balance sheet. The asset sales must generate sufficient cash to pay these costs before the common shareholders receive any residual cash. 12.3 The accounting for each of these transactions potentially involves transfers between contributed capital and retained earnings accounts and clouds the distinction between capital transactions and operating transactions. The market value method of accounting for stock options results in a reduction in net income and retained earnings and an increase in contributed capital. The accounting for stock dividends results in a reduction in retained earnings and an increased in contributed capital. The purchase of treasury stock represents a reduction in both contributed capital and accumulated earnings. The reissuance of treasury stock at a “loss” may result in a debit to both contributed capital and retained earnings. Thus, the Common Stock and Additional Paid-in Capital accounts do not reflect just capital transactions and Retained Earnings does not reflect just operating transactions. 12.4 The three provisions provide different benefits and risks to the issuing firm and the investor and should sell at different prices. Callable preferred stock should sell for less than convertible preferred stock. The issuing firm gains benefits with an option to call, or repurchase, the preferred stock and must thereby accept a lower issue price. The investor gains benefits with an option to convert into common stock and must pay a higher price. The mandatory redemption requirement makes the preferred stock more like debt than shareholders’ equity. Its market price depends on market interest rates for similar maturity debt (versus the 4 percent yield on the preferred stock) and the rank-ordering priority of the preferred stock in bankruptcy.
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Solutions 12-2 12.5 All three items permit their holder to acquire shares of common stock at a set price. Their values depend on the difference between the market price and the exercise price on the exercise date and the length of the exercise period.
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This note was uploaded on 04/23/2010 for the course B 101 taught by Professor Mcafee during the Winter '10 term at UMBC.

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