Question

1. Following is the shareholders’ equity section of Morgan Supplies on a day its common stock is trading at $77 per share.

Common stock ($2 par value, 30,000 shares issued and outstanding)	$ 60,000
Additional paid-in capital on common stock	1,200,000
Retained earnings	3,000,000

Required:

a. Use the financial statement template below to show the financial statement effects of

the following dividend events. (Assume that the events are independent.)

(1) Cash dividend declaration and payment of $1 per share

(2) Property dividend declaration and payment of shares representing a short-term

investment in Screen Products, Ltd., with a fair value of $15,000

(3) 10 percent stock dividend

(4) 100 percent stock dividend

(5) 3-for-1 stock split

(6) 1-for-2 reverse stock split

					Shareholders’ Equity
Entry	Assets	=	Liabilities	+	CC	+	AOCI	+	RE
1	Cash 30,000
2
3
4
5
6

Journal entry (optional):

b. Which events changed the book value of common equity?

c. Under what conditions will these events lead to future increases and decreases in ROE?

Please give more details with the answer!

Answer 1

Part a)

The template is completed as below:

					Shareholder's Equity
Entry	Assets	=	Liabilities	+	CC	+	AOCI	+	RE
1	Cash (30,000)								Retained Earnings (30,000)
2	Investment (15,000)								Retained Earnings (15,000)
3					Common Stock +6,000 APIC + 225,000				Retained Earnings (231,000)
4					Common Stock +60,000				Retained Earnings (60,000)
5	NA-Memorandum Entry
6	NA-Memorandum Entry

______

Part b)

The journal entries are given as follows:

Entry	Account Titles	Debit	Credit
1	Retained Earnings	$30,000
	Cash		$30,000
2	Retained Earnings	$15,000
	Investments		$15,000
3	Retained Earnings	$231,000
	Common Stock (30,000*10%*2)		$6,000
	APIC [30,000*10%*(77-2)]		$225,000
4	Retained Earnings	$60,000
	Common Stock [30,000*100%*2]		$60,000
5	No Journal Entry Needed
6	No Journal Entry Needed

Any change in the value of common stock, retained earnings and APIC (as indicated by above journal entries) will result in a change in the book value of common equity.

______

Part c)

The ROE indicates the ratio of net income to shareholder's equity. Any increase in net income with constant shareholder's equity will lead to an increase in ROE. Similarly, any decrease in shareholder's equity with constant net income will lead to increase in ROE. The ROE would decrease if net income remains constant and shareholder's equity increases or net income decreases and shareholder's equity increases. The company's decision to pay dividends and/or retain profits for company's growth plans can influence the ROE in future. For Instance, non payment of dividends would result in a decrease in ROE assuming constant net income. However, retention of profits for expansion/growth projects can lead to capital appreciation for investors in the long run which would improve ROE in future.