Fundamentals Of Financial Accounting 6th Edition By Fred Phillips – Test Bank

Chapter 11 Stockholders’ Equity

1) Corporations are governed by federal law.

Answer: FALSE
Explanation: To protect everyone’s rights, the creation and oversight of corporations are tightly regulated by law. Corporations are created by submitting an application to a state government (not the federal government).
Difficulty: 2 Medium
Topic: Corporate Ownership
Learning Objective: 11-01 Explain the role of stock in financing a corporation.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

2) A major advantage of debt financing is that interest expense is tax deductible.

Answer: TRUE
Explanation: Interest on debt is tax deductible; whereas, dividends on stock are not tax deductible.
Difficulty: 1 Easy
Topic: Corporate Ownership
Learning Objective: 11-01 Explain the role of stock in financing a corporation.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

3) Issuing stock to obtain financing is called equity financing.

Answer: TRUE
Explanation: The two main ways that corporations finance their operations are by issuing stock (equity financing), or by borrowing (debt financing).
Difficulty: 1 Easy
Topic: Corporate Ownership
Learning Objective: 11-01 Explain the role of stock in financing a corporation.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

4) Treasury stock is a corporation’s own stock that has been issued and subsequently repurchased by the corporation.

Answer: TRUE
Explanation: Treasury Stock reports shares that were previously issued to and owned by stockholders but have been reacquired and are now held by the corporation.
Difficulty: 1 Easy
Topic: Common Stock Transactions
Learning Objective: 11-02 Explain and analyze common stock transactions.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

5) A corporation’s charter establishes the number of shares of stock that will be issued in an initial public offering (IPO).

Answer: FALSE
Explanation: The very first issuance of a company’s stock to the public is called an initial public offering, or IPO; some companies remain private. A corporation’s charter indicates the maximum number of shares of stock that the corporation is allowed to issue (also referred to as the number of authorized shares).
Difficulty: 2 Medium
Topic: Common Stock Transactions
Learning Objective: 11-02 Explain and analyze common stock transactions.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

6) The par value of stock indicates what the stock is worth.

Answer: FALSE
Explanation: The par value insignificant value per share of capital stock specified in the charter. Par value is a legal concept and is not related in any way to the market value of the company’s stock.
Difficulty: 1 Easy
Topic: Common Stock Transactions
Learning Objective: 11-02 Explain and analyze common stock transactions.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

7) When a company reissues (or sells) shares of its treasury stock at an amount different than its cost, it reports a gain or a loss on the sale.

Answer: FALSE
Explanation: When a company reissues shares previously reported as treasury stock, it does not report a gain or loss on sale, even if it issues the shares for more or less than they cost when the company reacquired them. GAAP does not permit a corporation to report income or losses from investments in its own stock because transactions with the owners are not considered profit-making activities.
Difficulty: 2 Medium
Topic: Common Stock Transactions
Learning Objective: 11-02 Explain and analyze common stock transactions.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

8) A corporation does not have a legal obligation to pay dividends.

Answer: TRUE
Explanation: Dividends are not an obligation of the corporation and become a liability only when the board of directors formally declares a dividend.
Difficulty: 2 Medium
Topic: Cash Dividends on Common Stock
Learning Objective: 11-03 Explain and analyze cash dividends, stock dividends, and stock split transactions.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation

9) A company that pays no dividends is always a poor investment.

Answer: FALSE
Explanation: Investors acquire common stock because they expect a return on their investment. This return can come in two forms: dividends and increases in stock price. Some investors prefer to buy stocks that pay little or no dividends (called a growth investment) because companies that reinvest the majority of their earnings tend to increase their future earnings potential, along with their stock price.
Difficulty: 2 Medium
Topic: Cash Dividends on Common Stock
Learning Objective: 11-03 Explain and analyze cash dividends, stock dividends, and stock split transactions.
Bloom’s: Evaluate
AACSB: Analytical Thinking
Accessibility: Keyboard Navigation

10) State laws often restrict dividends to the amount of Retained Earnings.

Answer: TRUE
Explanation: The corporation must have accumulated a sufficient amount of Retained Earnings to cover the amount of the dividend. State laws often restrict dividends to the balance in Retained Earnings.
Difficulty: 2 Medium
Topic: Cash Dividends on Common Stock
Learning Objective: 11-03 Explain and analyze cash dividends, stock dividends, and stock split transactions.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation