Financial Accounting: In an Economic Context

PROBLEMS

P12-1

Hybrid securities and debt covenants

Lambert Corporation issued 1,000 shares of $100 par value, 8 percent, cumulative, nonpar-ticipating preferred stock for $100 each. The stock is preferred to assets, redeemable after five years at a prespecified price, and the preferred shareholders do not vote at the annual shareholders' meeting. The condensed balance sheet of Lambert prior to the issuance follows:

Lambert has entered into a debt agreement that requires the company to maintain a debt/ equity ratio of less than 1:1.

REQUIRED:

a. Provide the journal entry to record the preferred stock issuance, and compute the resulting debt/equity ratio, assuming that the preferred stock is considered an equity security.

b. Compute the debt/equity ratio, assuming that the preferred stock is considered a debt security.

c. What incentives might the management of Lambert have to classify the issuance as equity instead of debt? Do you think that the issuance should be classified as debt or equity? What might Lambert's external auditors think?

P12-2

The effects of treasury stock transactions on important financial ratios

The balance sheet of Alex Bros. follows:

Of the 200,000 common shares authorized, 50,000 shares were issued for $8 each when the company began operations. There have ...