FAR 1A4 Equity

Question 1

How are unrealized gains/losses on equity securities reported?

Answer 1

✅ Included in net income 📈
✅ Affects retained earnings 💰
✅ This includes available-for-sale (AFS) equity securities because equity securities are measured at fair value.

Question 2

Where are unrealized losses on available-for-sale (AFS) debt securities reported?

Answer 2

✅ They are included in shareholder’s equity as a component of accumulated other comprehensive income (AOCI).

Question 3

What increases and decreases retained earnings?

Answer 3

✅ Increases:
📈 Net income
🔄 Prior-period adjustments
🔄 Quasi-reorganizations

❌ Decreases:
📉 Net losses
📉 Prior-period adjustments
💸 Cash, property, scrip, and stock dividends
📉 Treasury stock transactions and stock retirements

Question 4

What happens when debt is settled using stock or property?

Answer 4

✅ If the fair value of the stock or property is less than the carrying amount of the debt, the difference is recognized as a gain 📈
✅ This gain increases retained earnings.
✅ The fair value of the stock issued is added to equity through common stock and additional paid-in capital (APIC).

Question 5

How should stock issued at market price be accounted for?

Answer 5

✅ Look at the date of issuance 📆
✅ If the issuance date matches the trading price date, then:
📊 The difference between the par value and the trading price is recorded in APIC.

Question 6

Where is the excess of proceeds over cost recorded when treasury stock is sold under the cost method?

Answer 6

✅ In APIC – Treasury Stock, NOT retained earnings.

Question 7

What does “unappropriated retained earnings” mean?

Answer 7

✅ It means the company has not yet allocated the earnings for a specific use.

Question 8

How does a stock dividend impact retained earnings and total equity?

Answer 8

✅ Retained earnings decrease 📉
✅ Total equity remains the same because the amount is reallocated to common stock and APIC.

Question 9

What happens when treasury stock is sold for less than its cost?

Answer 9

✅ Retained earnings decrease by the loss amount.
✅ Total equity remains unchanged, as the reduction in treasury stock is offset by the proceeds received.

Question 10

What happens when treasury stock is sold for more than its cost?

Answer 10

✅ The excess proceeds are recorded in APIC – Treasury Stock. 📈
✅ Retained earnings remain unaffected.

Question 11

What is the relationship between Accumulated Other Comprehensive Income (AOCI) and Other Comprehensive Income (OCI)?

Answer 11

✅ OCI captures current-period gains/losses.
✅ AOCI accumulates these amounts over multiple periods, similar to how retained earnings accumulate net income over time.

Question 12

If treasury stock is sold at a loss under the cost method, how is the loss accounted for?

Answer 12

✅ The loss is first charged to APIC – Treasury Stock.
✅ If APIC – Treasury Stock is insufficient, the remaining loss is deducted from retained earnings.

Question 13

Why does additional paid-in capital (APIC) increase when stock warrants are exercised, not when they are issued to existing shareholders?

Answer 13

📈 APIC increases in the year the warrants are exercised, because that’s when the company receives cash and issues new shares
📝 No entry is made when warrants are issued to existing shareholders, as there is no cash received or obligation created at issuance

Question 14

How is dividend revenue recognized when an investor owns both preferred stock (100%) and common stock (30%) in the same investee and exercises significant influence?

Answer 14

📈 Preferred Stock (Cost Method):
Dividends received are recorded as dividend income.

📉 Common Stock (Equity Method):
Dividends received are not recognized as income.
Instead, they reduce the investment account.

Key Rule:
Use the equity method for common stock if significant influence exists.
Use the cost method for preferred stock unless otherwise required.

Question 15

When does a company decrease retained earnings for a dividend on common stock?

Answer 15

📅 On the declaration date — when the board of directors formally declares the dividend and it becomes a legal obligation.
JE: Retained Earnings XXX Dividends Payable XXX
Rule: Not affected on the record date, payment date, or fiscal year-end — only on the declaration date.

Question 16

What are appropriated retained earnings, and how are they presented on the balance sheet?

Answer 16

📌 Appropriated retained earnings are set aside for a specific purpose (e.g., building projects, contingencies) by the board or management.
📊 They are disclosed as a separate component of retained earnings, but are still part of total equity.
🛑 They do not reduce total retained earnings — only classify a portion as restricted.

Question 17

When is an appropriation of retained earnings reversed?

Answer 17

✅ An appropriation is reversed when the reason for setting it aside is fulfilled (e.g., project completed).
🔁 The amount is reclassified back into unappropriated retained earnings.
❌ Appropriated RE is not affected by restricted cash or legal restrictions unless explicitly designated by management.

Question 18

How is net income handled at the end of the accounting year?

Answer 18

🔁 Net income is closed to retained earnings through the closing process.
📊 It becomes part of unappropriated retained earnings on the balance sheet when the financial statements are issued.
📥 All revenue and expense accounts are zeroed out to start the new year.

Question 19

What is the difference between unappropriated and appropriated retained earnings?

Answer 19

✅ Unappropriated retained earnings are available for dividends or general use.
🔒 Appropriated retained earnings are set aside by the board for a specific purpose and are not available for dividends until released.

Question 20

Does selling treasury stock above cost increase retained earnings under the cost method?

Answer 20

❌ No.
📈 Any excess of proceeds over cost is credited to APIC – Treasury Stock, not retained earnings.
💼 Retained earnings is only affected if shares are sold below cost and APIC – Treasury Stock is insufficient to absorb the loss.

Question 21

Does selling treasury stock above cost increase retained earnings under the par value method?

Answer 21

❌ No.
📈 Excess over par from reissuance is credited to APIC – Treasury Stock.
💼 Retained earnings is only affected if the reissue price is below par, and APIC is insufficient to absorb the shortfall.

Question 22

How is a treasury stock buyback recorded under the par value method when the repurchase price is below par?

Answer 22

🏷️ Record Treasury Stock at par.
📈 The difference between par and repurchase price is credited to APIC – Treasury Stock.
💼 This increases equity (but not retained earnings).

Par value = $10, Buyback price = $8, Shares repurchased = 100

Treasury Stock 1,000 (100 × $10)
Cr Cash 800 (100 × $8)
Cr APIC – Treasury Stock 200

Question 23

What happens if a company repurchases shares above par under the par value method, and APIC is insufficient to cover the excess?

Answer 23

📉 First, debit APIC – Treasury Stock for available balance.
💼 Then, debit Retained Earnings for any shortfall.
🧾 The repurchase cost above par must be fully absorbed by equity accounts.

Par value $10, Buyback $14, repurchased 100, APIC Treasury available 200

Treasury Stock 1,000 (100 × $10)
APIC – Treasury Stock 200
Retained Earnings 200
Cr Cash 1,400 (100 × $14)

Question 24

Where is treasury stock reported on the balance sheet?

Answer 24

📉 Treasury stock is reported as a contra-equity account in the stockholders’ equity section, not as an asset.
🧾 It reduces total equity, regardless of whether the cost or par value method is used.

Question 25

What are the key differences between the Par Value Method and the Cost Method for accounting for treasury stock?

Answer 25

🏷️ Par Value Method: - Treasury stock is recorded at par value. - Any difference between repurchase price and par is debited or credited to APIC – Treasury Stock, or Retained Earnings if APIC is insufficient. - Looks like a reversal of original issuance. 💰 Cost Method: - Treasury stock is recorded at the cost paid to repurchase. - APIC – Treasury Stock is only affected at reissuance, if reissued above or below cost. - Most commonly used method under U.S. GAAP. 📊 Key Rule: - Par method emphasizes par value and original issuance logic. - Cost method tracks the actual outflow and return from treasury transactions.

Question 26

How is the cancellation of treasury stock recorded under the cost method?

Answer 26

- Cancel shares by removing treasury stock at cost. - Reduce Common Stock at par value × shares canceled. - Reduce APIC from original issuance (if identifiable). - Any difference (if cost > original issuance) reduces APIC – Treasury or Retained Earnings. | (50,000 shares, $2.50 par, $13 cost) ## Footnote Common Stock (2.50 × 50,000) 125,000 APIC – Common Stock (e.g., 5/share) 250,000 APIC – Treasury or Retained Earnings 175,000 Cr Treasury Stock (13 × 50,000) 650,000

Question 27

How is the cancellation of treasury stock recorded under the par value method?

Answer 27

- Cancel shares by removing Common Stock at par. - Any excess of par over treasury cost is credited to APIC – Treasury. - If treasury cost > par, APIC – Treasury is debited or Retained Earnings if insufficient. | (50,000 shares, $2.50 par, $13 cost) ## Footnote Common Stock 125,000 APIC – Treasury (if shortfall) XXX Retained Earnings (if APIC shortfall) XXX Cr Cash or Treasury Stock 650,000

Question 28

When should a dividend be recognized as a liability on the balance sheet?

Answer 28

📅 A dividend is recorded as a liability only if it is declared on or before the balance sheet date 🕐 If declared after year-end but before the financials are issued, it is a subsequent event and disclosed, not recorded 📉 No reduction in retained earnings or liability is made until the declaration date