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Chapter 15: Question 2 Q (page 809)

Why is a preemptive right important?

Short Answer

Expert verified

As new shares are issued, and the company's ownership is diluted, preemptive rights prevent a shareholder from losing voting power.

Step by step solution

01

Definition of Preemptive Right

Preemptive rights are the rights given to the existing shareholders to purchase a newly shared issue before it is offered to someone else.

02

Importance of preemptive right

The involuntary dilution of ownership interestof existing stockholders can be protected by the preemptive right. In the absenceof this right, stockholders may find that the issuance of additional stock diminishes their interest without their knowledge and at unfavorable prices.

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Most popular questions from this chapter

In the absence of restrictive provisions, what are the basic rights of stockholders of a corporation?

Dividends are sometimes said to have been paid “out of retained earnings.” What is the error, if any, in that statement?

Briefly describe some of the similarities and differences between GAAP and IFRS with respect to the accounting for stockholders’ equity.

(Dividends and Stockholders’ Equity Section) Anne Cleves Company reported the following amounts in the stockholders’ equity section of its December 31, 2016, balance sheet.

Preferred stock, 10%, \(100 par (10,000 shares authorized, 2,000 shares issued)

\)200,000

Common stock, \(5 par (100,000 shares authorized, 20,000 shares issued)

100,000

Additional paid-in capital

125,000

Retained earnings

450,000

Total

\)875,000

During 2017, Cleves took part in the following transactions concerning stockholders’ equity.

  1. Paid the annual 2016 \(10 per share dividend on preferred stock and a \)2 per share dividend on common stock. These dividends had been declared on December 31, 2016.
  2. Purchased 1,700 shares of its own outstanding common stock for \(40 per share. Cleves uses the cost method.
  3. Reissued 700 treasury shares for land valued at \)30,000.
  4. Issued 500 shares of preferred stock at \(105 per share.
  5. Declared a 10% stock dividend on the outstanding common stock when the stock is selling for \)45 per share.
  6. Issued the stock dividend.
  7. Declared the annual 2017 \(10 per share dividend on preferred stock and the \)2 per share dividend on common stock. These dividends are payable in 2018.

Instructions

  1. Prepare journal entries to record the transactions described above.
  2. Prepare the December 31, 2017, stockholders’ equity section. Assume 2017 net income was $330,000.

(Stock and Cash Dividends) Earnhart Corporation has outstanding 3,000,000 shares of common stock with a par value of \(10 each. The balance in its Retained Earnings account at January 1, 2017, was \)24,000,000, and it then had Paid-in Capital in Excess of Par—Common Stock of \(5,000,000. During 2017, the company’s net income was \)4,700,000. A cash dividend of \(0.60 a share was declared on May 5, 2017, and was paid June 30, 2017, and a 6% stock dividend was declared on November 30, 2017, and distributed to stockholders of record at the close of business on December 31, 2017. You have been asked to advise on the proper accounting treatment of the stock dividend.

The existing stock of the company is quoted on a national stock exchange. The market price of the stock has been as follows.

October 31, 2017 \)31

November 30, 2017 \(34

December 31, 2017 \)38

Instructions

  1. Prepare the journal entry to record the declaration and payment of the cash dividend.
  2. Prepare the journal entry to record the declaration and distribution of the stock dividend.
  3. Prepare the stockholders’ equity section (including schedules of retained earnings and additional paid-in capital) of the balance sheet of Earnhart Corporation for the year 2017 on the basis of the foregoing information. Draft a note to the financial statements setting forth the basis of the accounting for the stock dividend, and add separately appropriate comments or explanations regarding the basis chosen.
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