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Fundamentals of Financial Accounting with Annual Report

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Chapter 11 - porting and Interpreting Stockholders’ Equity Chapter 11 Reporting and Interpreting Stockholders’ Equity ANSWERS TO QUESTIONS 1. A corporation is a separate legal entity (authorized by law to operate as if it were an individual). It is owned by a number of persons and/or entities whose ownership is evidenced by shares of common stock. Its primary advantage is the ease of participation in its ownership. This is related to the corporation’s: (a) transferability of ownership, (b) limited liability to the owners, and (c) the ability to sell ownership in small quantities, which can accumulate to large amounts of resources. 2. The advantages of equity financing are (1) equity does not have to be repaid, whereas debt must be repaid or refinanced and (2) dividends are optional, but interest on debt must be paid. The advantages of debt financing are (1) there is no change in stockholder control when debt financing is used whereas the additional issuance of stock dilutes the control of existing stockholders, and (2) interest expense is tax deductible whereas dividends are not tax deductible. 3. General Motors might have proposed the exchange of debt for equity to gain more flexibility in its future cash outflows. Debt typically requires periodic payment of interest until its mandatory principal repayment at maturity. On the other hand, equity does not require payment of dividends and equity does not require mandatory repayment. The bondholders might have rejected this proposal because they had acquired the bonds with an expectation of periodic cash payments. Also, bondholders have a higher priority than stockholders should the company go out of business and have its assets liquidated and distributed to creditors and stockholders. 4. (a) Authorized common stock—the maximum number of shares of stock that can be sold and issued as specified in the charter of the corporation. (b) Issued common stock—the total number of shares of capital stock that have been issued by the corporation at a particular date. (c) Outstanding common stock—the number of shares currently owned by the stockholders (equals issued stock minus treasury stock). 11-1
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Chapter 11 - porting and Interpreting Stockholders’ Equity 5. Common stock—the usual or normal stock of the corporation. It is the voting stock and generally ranks after the preferred stock for dividends and assets distributed upon dissolution. Often it is called the residual equity. Common stock may be either par value or no-par value. Preferred stock—when one or more additional classes of stock are issued, the additional classes are called preferred stock. Preferred stock has modifications that make it different from the common stock. Generally, preferred stock has both favorable and unfavorable features in comparison with common stock. Favorable features include its dividend preference over common stock and an unfavorable feature is that it typically is non-voting. Preferred stock usually is par value stock and usually specifies a dividend rate such as “6% preferred stock.”
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SM_Chap011 - Chapter 11 porting and Interpreting...

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