Darshan Argrawal, controller for Centre Corporation (a public company), wants to discuss with the company president, Rhonda Santo, the possibility of paying a stock dividend. Argrawal knows that the company does not have a huge amount of cash, but he is certain that Santo would like to give the shareholders something of value this year since it has been a few years since the company has paid any dividends. Argrawal also is concerned that the company’s cash position will not improve significantly in the near future. He feels that shareholders look to retained earnings and, if they see a large balance, they believe (erroneously, of course) that the company can pay a cash dividend. Argrawal wants to propose that the company pay a 100% stock dividend, as opposed to a cash dividend or a 2-for-1 stock split. He reasons (1) that the shareholders will receive something of value, other than cash; and (2) that retained earnings will be reduced by the stock dividend (as opposed to a split, which does not affect retained earnings) so shareholders will be less likely to expect cash dividends in the near future. For her part, Santo is interested in setting up a program that would have the company make loans to its top executives so that they can purchase new shares that will be issued by the company. This way, there is again no impact on cash yet the executives can participate in increases (hopefully) in the company share price. If all goes well, they can sell the shares, pay back the loans, and keep the difference. The loans are also secured by the company shares. If the share prices decrease, the company would not necessarily enforce collection of the receivable.
Instructions
Adopt the role of the company auditor and discuss the financial reporting issues.