Question

The stockholders' meeting for Percival Corporation has been in progress for some time. The chief financial officer for Percival is presently reviewing the company's financial statements and is explaining the items that comprise the stockholders' equity section of the balance sheet for the current year. The stockholders' equity section of Percival Corporation at December 31, 2017, is as follows.

Percival Corporation

Balance Sheet (partial)

December 31, 2017

Paid in Capital

Capital Stock

Preferred stock, authorized 1,000,000 shares

Cumulative, $100 par value, $8 per share, 6000

Shares issued and outstanding                                                                                  $600,000

Common stock, authorized 5,000,000 shares, $1 par

Value, 3,000,000 shares, issued and 2,700,000 outstanding                           3,000,000

                Total Capital stock                                                                                            3,600,000

Additional paid in capital

In excess of par- preferred stock                                              $50,000

In excess of par- common stock                                                25,000,000

Total additional pain in capital                                                                                     25,050,000

Total paid in capital                                                                                                          28,650,000

Retained Earnings                                                                                                                  900,000

Total paid in capital and retained earnings                                                            29,550,000

Less: Treasury Stock (300,000 common shares)                                                 9,300,000

Total Stockholder’s equity                                                                                           $20,250,000

At the meeting, stockholders have raised a number of questions regarding the stockholders' equity section.

Instructions

With the class divided into groups, answer the following questions as if you were the chief financial officer for Percival Corporation.

(a)  “What does the cumulative provision related to the preferred stock mean?”

Answer:

(b)  “I thought the common stock was presently selling at $29.75, but the company has the stock stated at $1 per share. How can that be?”

Answer:

(c)  “Why is the company buying back its common stock? Furthermore, the treasury stock has a debit balance because it is subtracted from stockholders' equity. Why is treasury stock not reported as an asset if it has a debit balance?”

Answer 1

a. "Cumulative "provision with respect to preferred stock means that the dividends agreed or declared in any year ,if not paid in that year , accumulates till the time they are fully paid to the preference shareholders.

They are entitled to these arrears of dividends ,even before any dividend payment to common stockholders.

In addition, the preference shareholders are entitled to the fixed percentage of dividends ,even if there is no profit ,in any year.In the next profit- making year, they are disbursed before any payment to common stock -holders.

b. $ 29.75 is the price of the stock quoted in the stock exchange , as decided by various factors such as investors' perception about the financial performance of the company,profitability,its management,social responsibility ,etc.

$ 1 is the nominal or face value of the share --ie. Accounted in the books of the company--ie.its book value

c.

Buying back its own common stock is known as repurchasing & is resorted to , for many reasons:

1. when there is excess-idle cash with the company and also heavy equity balance ,where the company has to pay heavy dividends,some managements prefer to return the capital & reduce further continuing dividend-burden.

2. when the management wants to correct the undervaluation of the company's shares in the market,which were a consequence of some short-term self-anamoly, capable of self-correction over time.The shares can be re-issued at an opportune time.

The shares so re-purchased are called Treasury Stock

They are like investing in one's own stock-- the company repurchases instead of retiring the same.

The company cannot declare any dividend for these stocks.

They will not have any voting rights

No.of treasury stocks is the difference between the no.of shares issued & the no.of shares outstanding.

The accounting entry will be debit Treasury stock & Credit cash

So, Treasury stock always has a debit balance & subtracted from total equity to show the actual amount due to equity-holders.

Treasury stock is not reported as an asset even though it has a debit balance because this does not qualify as any investment proposition but only an expansion or contraction of its own equity-outstandings --- derived as a result of some strategic decision-making ,aided by availability of adequate liquid cash.

These stocks can be re-issued or resold in the market ,or retained as such in the company's treasury.