8. HW5 - 4 points a. What is the effect of the 15% stock dividend on retained earnings (provide a dollar amount and state increase, decrease, or no effect)? b. What is the effect of the distribution of the 15% stock dividend on cash flows (provide a dollar amount and, if the amount is not zero, indicate whether it is a cash inflow or outflow and whether it would appear as an operating, investing, or financing activity in the cash flow statement)?

Clarence Company is a building contractor. Like all companies in the construction industry, there are some doubts about the collectability of its accounts receivable. Fiscal year. Clarence Company's fiscal year end is December 31 (12/31). The accounting year just ended for Clarence Company is the fiscal year ending December 31, 2008 (12/31/08). Retained earnings, pretax financial income, tax rates. Clarence's retained earnings on January 1, 2008 was $4,000,000 and its tax rate for all past fiscal years, including 2008, is 30%. The tax laws have changed and Clarence's tax rate for all years after 2008 will be 40%. Clarence's pretax financial income (i.e., accounting income before tax) is $2.2 million for fiscal 2008. Prior to 2008, Clarence never had any temporary or permanent differences between pretax financial income and taxable income (in other words, pretax financial income and taxable income always were the same prior to 2008). Investments. Clarence's Chief Financial Officer loves to invest, so he uses Clarence's money to invest in shares of other companies' stock. On 1/1/2007, Clarence purchased 1,000 shares of Llama Corporation. During fiscal 2008, Clarence purchased 1,000 shares of Goat Corporation. The Llama shares were purchased for $10.50 per share and the Goat shares were purchased for $7.20 per share. At the end of fiscal 2007, the fair market value of Llama was $10.90/share. At the end of fiscal 2008, the shares of Llama and Goat were worth $10.50 and $7.20 per share, respectively. Llama Corporation declared and paid cash dividends of $0.75 per share in both 2007 and 2008; Goat Corporation declared and paid a cash dividend of $0.50 per share in fiscal 2008. Clarence's share of Llama's stockholders' equity at the date of purchase was 10,000, with the entire difference between cost and book value attributable to equipment with a remaining useful life of five years (Llama uses straight-line for all depreciation and amortization). Llama's total net income was $3,000 in 2007 and $3,500 in 2008. 6% Bonds. On July 1, 2007, Clarence issued 800 bonds. The bonds are 6% stated (face, coupon) rate, 10-year, non-convertible, callable bonds (each bond has a face value of $1,000 and they were issued at 107.7214). The bonds pay interest annually on July 1. The bond issue price was based on an effective interest rate of 5%. The bonds are callable anytime at 96 plus accrued interest. 5.5% Convertible bonds. In 2005, Clarence issued, at face value, $1,000,000 of 5.5%, 8-year, convertible, non-callable bonds (that is, it issued 1,000 bonds that each have a face value of $1,000). Each bond can be converted anytime by the bondholder into 24 shares of common stock. The bonds were issued on January 1, 2005 and pay interest annually on January 1. The effective interest method is used to amortize all bond discount or premium. Common Stock. On 1/1/08, there were 900,000 shares of $1 par value common stock authorized and 360,000 shares issued and outstanding. The 360,000 shares were originally issued on August 12, 2001 for $32 per share. Consequently, the balance in the paidin capital from common stock account on 1/1/08 totals $11,160,000. The market price of Clarence's stock typically fluctuates quite a bit. The next page contains detailed information about Clarence's common stock price. 8% Convertible, cumulative, non-participating, Preferred Stock. There are 850 shares of $1,000 par, 8% preferred stock issued and outstanding. The preferred stock is cumulative and nonparticipating. Each share of preferred stock is convertible into four (4) shares of common stock. The preferred stock was issued at par in 1995. Preferred stock dividends were last declared and paid in fiscal 2006. Treasury Stock. Clarence purchased 40,000 shares of treasury stock on 4/1/08 for $32 per share and reissued 20,000 of these shares on 9/1/08 for $37 per share. Clarence uses the cost method to account for treasury stock transactions. Cookies or peanuts? Clarence's CFO was on an airplane last week visiting the PCAOB and the flight attendants were asking if the passengers would like cookies or peanuts. Not one person asked \"what kind of cookies?\" People need to be more curious. 3 Stock options as compensation. On November 1, 2007, Clarence announced that it planned to implement a compensatory stock option planthe company would distribute 40,000 options, each of which allows the holder to purchase a share of stock for $40. Only employees in management would be eligible. On December 1, 2007, the company distributed the 40,000 options as planned. The employees eligible for the plan must work for the company until December 1, 2010, at which time the options can be exercisedall eligible employees are expected to remain with the company until they earn the options. As of December 1, 2007, the company forecasts that the market price per share will be $64 on December 1, 2010. The options expire on June 30, 2011. Using an option pricing model, the company estimates that each option was worth $19 on November 1, 2007, $21 on December 1, 2007, and $23 on December 31, 2008. See below for the price of the common stock on each of those dates. Stock dividend. On October 1, 2008, Clarence declared a 15% stock dividend. The dividend was distributed on November 1, 2008. Cash dividend. On December 15, 2008, Clarence declared a total cash dividend of $500,000 payable to preferred and common stockholders of record as of December 20, 2008. It will be paid on December 30, 2008. Inventory error. The company counted inventory incorrectly as of 12/31/08. As a result, ending inventory for the year ended 12/31/08 was overstated by $4,000. Accrued wages errors. Clarence forgot to accrue $3,400 of wages payable as of 12/31/07. All of these wages were paid and expensed early in fiscal 2008. Market value per share of common stock at the end of fiscal 2007, throughout Fiscal 2008, and for January 1, 2009: Nov 1 2007 $33 Dec 1 2007 $34 Dec 31, 2007 Jan 1 2008 $35 Feb 1 2008 $37 Mar 1 2008 $42 April 1 2008 $32 May 1 2008 $34 June 1 2008 $45 July 1 2008 $40 Aug 1 2008 $41 Sept 1 2008 $39 Oct 1 2008 $29 Nov 1 2008 $31 Dec 1 2008 $37 Dec 31 2008 $55 Average for fiscal 2008 $41 Jan 1 2009 $55 8. HW5 - 4 points a. What is the effect of the 15% stock dividend on retained earnings (provide a dollar amount and state increase, decrease, or no effect)? b. What is the effect of the distribution of the 15% stock dividend on cash flows (provide a dollar amount and, if the amount is not zero, indicate whether it is a cash inflow or outflow and whether it would appear as an operating, investing, or financing activity in the cash flow statement)