F1 M3

Background from the question:

At Dec 31, Year 1, Eagle had ( $1,750,000 ) appropriated retained earnings for a new office building.

The office building was completed in Year 2, costing ( $1,500,000 ).

In Year 2, Eagle appropriated ( $1,200,000 ) of retained earnings for a new plant.

Additionally, there was ( $2,000,000 ) of cash restricted for bond retirement, due in Year 3.

Why only ( $1,200,000 ) is reported as appropriated retained earnings at Dec 31, Year 2:

Appropriated retained earnings represent a portion of retained earnings set aside (restricted) for a specific purpose but still part of equity, not paid out.

The ( $1,750,000 ) from Year 1 was appropriated for the construction of the office building.

Since the office building was completed in Year 2 at a cost of ( $1,500,000 ) (less than the appropriation amount), this appropriation is no longer needed once the purpose is met.

When construction (the purpose of the appropriation) is complete, this amount is reversed or restored back to unappropriated retained earnings (general retained earnings), because there’s no longer a need to set it aside.

Therefore, the ( $1,750,000 ) appropriation is removed from appropriated retained earnings in Year 2.

What remains appropriated at the end of Year 2?

The new appropriation of ( $1,200,000 ) for the new plant is still valid and outstanding as of Dec 31, Year 2.

Hence, the only amount to show as appropriated retained earnings on the Year 2 balance sheet is ( $1,200,000 ).

Why the cash restricted for bonds does NOT increase appropriated retained earnings:

( $2,000,000 ) cash restricted for bond retirement is an asset restriction, not a retained earnings appropriation.

This restricted cash is shown elsewhere on the balance sheet (likely as a restricted cash asset), not as part of appropriated retained earnings.

Summary:

Appropriated retained earnings at Dec 31, Year 2 = $1,200,000

Because the initial appropriation for the office building is reversed when the project is complete, and the bond retirement cash restriction does not affect retained earnings.

Choice "C" is correct. Using the cost method, the treasury stock transactions include the reissuance of the treasury shares at $10 per share ($4 per share to APIC x 500 shares = $2,000). The additional paid-in capital from the original issuance of the stock is not paid-in capital related to the treasury stock and is not included.

Given:

Preferred stock: 4,000 shares, $100 par, 6% cumulative

Common stock: 20,000 shares, $10 par

Dividends in arrears at Dec 31, Year 1 = $12,000

Total cash dividends declared in Year 2 = $44,000

Step 1: Calculate annual preferred dividend

Preferred dividend is based on par value, stated rate, and shares outstanding:

4,000 shares x $100 x 6% = $24,000

This is the dividend that should be paid each year for the preferred stock.

Step 2: Add dividends in arrears (cumulative feature)

Since the stock is cumulative, any unpaid preferred dividends from prior years must be paid before common shareholders get dividends.

Dividends in arrears = $12,000 (from prior year)

Current year preferred dividend = $24,000

Total preferred dividends due this year =

12,000 + 24,000 = 36,000

Step 3: Calculate remaining dividends for common shareholders

Total dividends declared = $44,000

Subtract preferred dividends due:

44,000 - 36,000 = 8,000

So, $8,000 is available for common stockholders.

Summary:

Preferred stockholders receive $36,000 (including arrears and current year)

Common stockholders receive $8,000

This matches option D.

Why other options are wrong:

If preferred dividends were less than $36,000, that would mean ignoring accrued arrears, which is not allowed for cumulative preferred stock.

Giving all $44,000 to preferred stock ignores the common stock shareholders, who get paid only after preferred dividends are fully met.

Dividing dividends differently without covering arrears misses the priority rule of cumulative preferred stock.

Choice "A" is correct. $425,000 ($500,000 - $75,000). Shares of its own stock held by a corporation should be recorded as treasury stock and shown as a reduction in the stockholders' equity section of the B/S.

Choice "A" is correct. Disclosure of $20,000 dividends in arrears in the Year 3 financial statements. Dividends are not reported as a liability until the dividends are declared. The total amount of dividends in arrears includes both the Year 2 and Year 3 accumulated dividends, less the dividend paid, because the dividends are cumulative.

Context:

Rya Corp issued two types of stock simultaneously:

1,000 shares of common stock (par value $20)

2,000 shares of convertible preferred stock (par value $20)

Total cash received: $80,000

Market prices per share at issue:

Common stock: $36 per share

Preferred stock: $27 per share

The task:

Allocate the total proceeds ($80,000) between the common stock and the preferred stock based on their relative fair market values at the time of issuance.

Step 1: Calculate total fair value of each class of stock

Common stock fair value:

1{,}000 \text{ shares} \times $36 = $36{,}000

Preferred stock fair value:

2{,}000 \text{ shares} \times $27 = $54{,}000

Step 2: Calculate the total combined fair value

$36{,}000 + $54{,}000 = $90{,}000

Step 3: Allocate the actual proceeds ($80,000) based on relative fair values

Allocation to preferred stock:

\frac{$54{,}000}{$90{,}000} \times $80{,}000 = \frac{54}{90} \times 80{,}000 = 0.6 \times 80{,}000 =$48{,}000

Allocation to common stock:

$80{,}000 - $48{,}000 = $32{,}000

Why allocate this way?

You need to allocate proceeds in proportion to the fair values because you received $80,000 for both stocks combined, but their relative market prices show how much value each contributed.

Simply assigning based on par value is incorrect because par is just a nominal number, not indicative of market value.

The preferred stock has a lower market price, but since you have more preferred shares, its total market value ($54,000) is higher than that of common stock ($36,000).

This method is called allocation based on relative fair market value.

Summary:

Preferred stock: $48,000 of the proceeds allocated

Common stock: $32,000 of the proceeds allocated

That’s why option D ($48,000 allocated to preferred stock) is correct.

Shares issued: 20,000 shares at $10 each (par $5 + $5 additional paid-in capital)

Retained earnings at 12/31/Year 1: $300,000

Treasury stock reacquired: 5,000 shares at $20 each (in March, Year 2)

Treasury stock sold: 1,000 shares at $25 each (in June, Year 2)

Year 2 net income: $60,000

Accounting method: Cost method for treasury stock

Why the retained earnings do NOT change with treasury stock transactions under the cost method

Treasury stock is recorded at the repurchase cost, here $20 per share.

When treasury shares are reissued (sold), the difference between the selling price and the cost affects additional paid-in capital, treasury stock (APIC-TS), not retained earnings.

Calculations:

Initial retained earnings (12/31/Year 1): ( 300,000 )

Add net income for Year 2: ( +60,000 )

No effect from treasury stock transactions on retained earnings here.

Retained Earnings at 12/31/Year 2 = 300,000 + 60,000 = 360,000

What about the treasury stock sales gain?

Gain per share on resale = ( 25 - 20 = 5 )

Total gain = ( 1,000 x 5 = 5,000 )

This $5,000 gain is credited to APIC-Treasury Stock, part of stockholders’ equity, but not to retained earnings.

Why other options are incorrect:

Some options incorrectly add the gain from treasury stock resale into retained earnings, this isn’t allowed under the cost method.

The shares’ original issuance price or par value is irrelevant to treasury stock resale gains/losses for retained earnings.

Losses on treasury stock sales might reduce APIC-TS first, then retained earnings if APIC-TS is insufficient, but that’s not the case here.

In summary:

Retained earnings only change by net income and dividends, not by treasury stock transactions recorded under the cost method. Since no dividends are mentioned, the correct retained earnings at year-end is:

360,000

When a company reacquires its own shares and holds them as treasury stock, any transactions related to treasury stock do not affect net income.

Treasury stock is recorded using the cost method here, so when Murphy repurchased 30,000 shares at $15 each, it debited treasury stock at $450,000 (30,000 × $15).

When Murphy reissued those shares at $20 each, the cash received was (30,000 \times 20 = 600,000). </p><p>The difference between the reissue price and cost ((600,000 - 450,000 = 150,000)) is recorded as an increase in additional paid-in capital from treasury stock transactions, not as a gain on the income statement. </p><p>The problem states Murphy recognized a$50,000 gain on the income statement, which is incorrect because treasury stock transactions don’t generate gains or losses impacting net income.

By incorrectly recording that gain on the income statement, Murphy overstated net income (and consequently retained earnings), which misstates profitability.

So, the error is treating the difference between purchase cost and reissue proceeds as a gain or loss on the income statement—this is not allowed under GAAP. Instead, it adjusts equity accounts (additional paid-in capital).

That’s why the correct statement is that net income is overstated.

Jan. 5 ISSUED 20,000 shares, $10 par at $15

July 14 PURCHASE OF TREASURY STOCK

5,000 shares at $17 = $85,000

Dec 27 TREASURY STOCK REISSUANCE

5,000 shares at $20 = $100,000

APIC: $100,000 - 25,000 + 50,000 =  $125,000