At December 31, year 1, Rama Corp. had 20,000 shares of 1 par value treasury stock that had been acquired in year 1 at 12 per share. In May year 2

Question:

At December 31, year 1, Rama Corp. had 20,000 shares of 1 par value treasury stock that had been acquired in year 1 at 12 per share. In May year 2, Rama issued 15,000 of these treasury shares at 10 per share. The cost method is used record treasury stock transactions. Rama is located in a state where laws relating to acquisition of treasury stock restrict the availability of retained earnings for declaration of dividends. At December 31, year2 should Ram to , what amount a show in notes to financial statements as a restriction of retained earnings as a result of its treasury stock transactions? a. 5,000 b. 10,000 С. 60,000 d. 90,000

Answer:

Here is the breakdown of the treasury stock transactions and the calculation of the restriction of retained earnings:

Year 1:

  • Purchased 20,000 shares of treasury stock at $12 per share:
    • Cost of treasury stock = 20,000 shares * $12/share = $240,000

Year 2:

  • Issued 15,000 shares of treasury stock at $10 per share:
    • Proceeds from issuance = 15,000 shares * $10/share = $150,000
    • Gain on sale of treasury stock = $150,000 – $240,000 = -$90,000 (negative value indicates a loss)
  • Retained earnings restricted by treasury stock laws:
    • Cost of treasury stock retained = 5,000 shares * $12/share = $60,000
    • Total restriction of retained earnings = $60,000

Therefore, at December 31, year 2, Rama should show a restriction of retained earnings of $60,000 in the notes to its financial statements as a result of its treasury stock transactions.

Here’s the explanation for each answer choice:

  • a. $5,000: This is not correct because it only considers the gain on the sale of treasury stock and ignores the restriction on retained earnings due to the remaining treasury stock.
  • b. $10,000: This is not correct because it only considers the face value of the treasury stock issued and ignores the cost of the treasury stock and the restriction on retained earnings.
  • c. $90,000: This is not correct because it only considers the loss on the sale of treasury stock and ignores the restriction on retained earnings due to the remaining treasury stock.
  • d. $240,000: This is not correct because it is the total cost of all the treasury stock acquired, not just the amount restricted by the treasury stock laws.

I hope this explanation clarifies the calculation of the restriction of retained earnings. Let me know if you have any further questions.

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