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Unformatted text preview: Solutions Manual, Chapter 13 347 13 CORPORATIONS: PAID-IN CAPITAL, RETAINED EARNINGS, DIVIDENDS, AND TREASURY STOCK ANSWERS TO QUESTIONS 1. Stockholders equity consists of paid-in capital and retained earnings. Paid-in capital mainly represents the investment made by stockholders in the corporation in expectation of profits. Such investment may be carried in a number of accounts. Retained earnings are undistributed income of the corporation and result from the deliberate actions of the corporation to secure such income through its operations. 2. Basically, the largest components of paid-in capital consist of capital received in exchange for shares of stock issued. These amounts are shown in the Preferred Stock, Common Stock, and Paid-In Capital in Excess of Par (or Stated) Value accounts. But paid-in capital also includes donated capital and capital arising from treasury stock transactions or stock dividends. The accounting objective of showing the sources of capital would not be fulfilled if only one account called Paid-In Capital were used to accumulate all of the corporation's capital. 3. Accounting for treasury stock does resemble accounting for an asset, and the terminology ordinarily used in association with treasury stock ("buy, sell, gain, loss") resembles that used for assets; but treasury stock is not an asset. The balance of the account represents the amount of capital that has been returned to stockholders, and it is shown as a deduction from the sum of paid-in capital and retained earnings in the balance sheet. 4. A corporation may wish to reacquire its own capital stock as treasury stock in order to (1) cancel and retire the stock, (2) reissue it at a later time at a higher price, (3) reduce the number of shares outstanding and thereby increase earnings per share, or (4) issue the stock to employees. 5. Such statutes are intended to prohibit return to stockholders of all or part of their investment in the corporation, to the possible detriment of the creditors. In effect, such laws limit total payments to stockholdersboth for dividends and for treasury stockto the amount of retained earnings. This limitation prevents the reduction of total stockholders' equity below the amount of stated or legal capital and thus protects creditors. 6. a. Cash dividend declarations reduce stockholders' equity. b. Cash dividend payments reduce liabilities and have no effect on stockholders' equity. c. Stock dividend declarations have no effect on total stockholders' equity; they merely transfer an amount from retained earnings to paid-in capital. d. Issuance of a stock dividend does not affect total stockholders' equity (or total paid-in capital, or total retained earnings)....
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