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Choices:stock rights, Changes vs errors vs change in methods

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Question 1

You own a small publically held company and are in need of raising new capital. You want to issue new shares of stocks but are unsure which type of stock to issue. You currently have 1,000,000 shares of common stock and 200,000 shares of preferred stock authorized. As of today, only 250,000 shares of common stock and 50,000 shares of preferred stock are outstanding.

What are the advantages and disadvantages of issuing both types of shares? Which type of shares would you decide to issue and why? What affect would the new issuance have on the financial statements?

Justify your answers with examples and reasoning. Comment on the postings and views of at least two peers concerning their rationales and examples used to justify their responses.

Question 2

You are planning on investing $15,000 in a company. You have two options that you are strongly considering. The first is with Company A's preferred stock, which is noncumulative, participating, and convertible. The second is with Company B's preferred stock, which is nonparticipating, cumulative, and convertible.

Which stock do you think is the better one to invest in and why? What are the advantages and disadvantages of each stock?

Question 3

Big Sports Company has been using the FIFO method for the past three years. This period, the company has decided to switch to the LIFO method.
Keeping the scenario in mind, discuss the reasons why a company might decide to make this change.
Analyze the effect that the change may have on the financial statements.
Discuss whether a company should restate the accounting change in the financial data of the prior years to reflect the new method? Or the accounting change should be reflected in the current and future years. Why?
Does any sort of change in the accounting principle, may result in dilution of public confidence in financial reporting? Why or why not?
Discuss whether the companies should follow a retroactive or retrospective approach while incorporating an accounting change.
Sometimes a company cannot retrospectively adjust their statements, even with best efforts and intentions. Discuss what should the company can do in such a situation?

When preparing the periodic physical count for Inventory, Big Sports Company has found some of its inventory has become obsolete. Scoreboards, previously accounted for on the financial statements valued at $500,000, now have a fair market value of $200,000 and they are not expected to recover their value.
Assess the proper treatment to account for the reduction in value of the scoreboards.
Evaluate how the disclosure should be treated in this instance.
Analyze what effect this would have on the financial statements.

Question 4

Gigantic Sports Co. owns the land and building where its inventory is being warehoused. When it purchased the land two years ago, the company incorrectly expensed the cost of paving in the period.

What should they have done with the costs associated with paving? Should the financial statements be affected at all with this change? If multiple instances such as this one occur, are the errors going to affect shareholder perception? Why or why not?

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Solution Summary

Your four discussion amount to 873 words and give general theory about accounting changes. Examples are given for all four questions and the reasoning behind stock choices are given. A set of journal entries is given to illustrate the reserve for obsolete inventory.

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Intermediate Financial Accounting II - Stockholders & Accounting Changes
Question 1
You own a small publically held company and are in need of raising new capital. You want to issue new shares of stocks but are unsure which type of stock to issue. You currently have 1,000,000 shares of common stock and 200,000 shares of preferred stock authorized. As of today, only 250,000 shares of common stock and 50,000 shares of preferred stock are outstanding.
What are the advantages and disadvantages of issuing both types of shares? Which type of shares would you decide to issue and why? What affect would the new issuance have on the financial statements?
Justify your answers with examples and reasoning. Comment on the postings and views of at least two peers concerning their rationales and examples used to justify their responses.
Discussion:
Common stock and preferred stock have different rights. Preferred stock receives dividends, if declared, prior to common stockholders. From the issuer's point of view, both stocks generated permanent owner contributions. Dividends, once declared, go to owners, regardless of the split between preferred and common shares. The contributions received would be recorded in the equity section (for both shares) and increase total equity. So, from a strictly balance sheet point of view, there is little difference. From an income statement point of view, however, there is a different. Preferred dividends, but not common dividends, are removed from the numerator for the computation of earnings per share (EPS). So, to maximize EPS, common stock is preferable. So, if the capital markets are equally interested in both types of shares and so the contributions expected in total were the same, I would issue common stock.

Question 2
You are planning on investing $15,000 in a company. You have two options that you are strongly considering. The first is with Company A's preferred stock, which is noncumulative, participating, and convertible. The second is with Company B's preferred stock, which is nonparticipating, cumulative, and convertible.
Which stock do you think is the better one to invest in and why? What are the advantages and disadvantages of each stock?
Discussion:
My decision would be based on my assessment about whether the dividends will be large and consistent. If they are ...

Solution provided by:
Carol Sargent, PhD
Education
  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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