Jimmy Fu and Moog, Inc. Understanding Shareholder's Equity (Brief Case) Case Solution

1. In the third transaction, the previous purchase of the share by the company must have been recorded in the treasury shares account. Since the company is now issuing these shares to the employees, the balance of the treasury shares must be reduced by the initial amount in which it was increased when the stock was purchased. The transaction will increase total shareholder’s equity. However, the number of shares would increase traded in the market would increase and the price paid (exercise price) for additional shares is likely to be lower than the market price, which would lead to a reduction in market price and a decline in value of Jimmy’s stock and options.

The fourth transaction would have no effect on the total shares outstanding of all the classes. However, it would reduce the number of Class B shares and incur a corresponding increase in Class B shares. However, the total shareholders’ equity will remain the same. The price of Class A and Class B shares may be affected by the transaction. For example, if Class A shares are trading at a higher price than Class B shares, the conversion of the lower-value Class B shares into the higher-value Class A shares might result in a slight decrease in the value of Class A shares and a slight increase in the value of Class B shares. Therefore, the change in the value of Jimmy’s shares would depend on the class of shares that he is holding.

In the last transaction during 2007, the $16.5 million loss of foreign exchange transactions may be recorded in other comprehensive income, while the profit of $64.79 million would increase the retained earnings by the same amount, as there are no dividend payments. The net effect would be an increase in total shareholders’ equity of $48.29 million. The impact of this transaction on stock price in uncertain. If the net income is bigger than expectations, the stock price might increase and Jimmy might benefit. In the other case, stock price might remain the same or decrease if the net income is equal to or lower than expectation, respectively.

2. The shareholders equity section of the balance sheet for the year ended September 30, 2007 is shown in the attached excel spreadsheet. The effect of each of the transactions, during the year, on different equity accounts is also shown.

3. For the year 2008, the first transaction would increase the amount of outstanding shares by 2,875,000. The Class A shares account would increase by the par value of the shares issued, which is $2.875 million. The difference between the par value and the actual gross proceeds from the share issue would be recorded in additional paid-in capital – this amount equals $86.25 million. The costs incurred for the share issue equals the difference between gross proceeds from the issue and the net proceeds. This difference of $4.625 million would be recorded as an expense in the income statement and reflected in the retained earnings account. The cash flow from this transaction would increase by the amount of $84.25 – the net proceeds from the issues. However, this amount would be used to repay outstanding credit facility borrowing.

For the second transaction, it is assumed that the average exercise price of the stock options would be the same as the average purchase price of $5.33. The balance of the treasury shares account will be reduced by the amount paid for the shares. As treasury shares account is a contra-equity account, the total shareholders’ equity would increase. The cash balance of the company would also increase by the total exercise price paid by the employees.

In the absence of any dividends, the reported net income in the third transaction would be result in an increase in retained earnings by the same amount.