Accounting Theory 14

Unit 2 Individual Project
Presented in Partial Fulfillment
Of the Requirements for the Class
ACG 450 – Advanced Topics in Accounting

By

Jason T. Rose
AIU Online
24 November 2005

1. Determine the income under each of the following equity theories:

o Proprietary theory
Net Income = Operating margin – Interest expense
= $300,000 - $80,000
= $220,000
o Entity theory (orthodox view)
Net Income = Revenue – Operating expense
= $1,000,000 - $700,000
= $300,000
Net Income in this theory also equals the operating margin.
o Entity theory (unorthodox view)
Net Income = Operating margin – (Interest expense + Dividends preferred       stock + Dividends common stock)
= $300,000 – ($80,000 + $30,000 + $100,000)
= $300,000 - $210,000
= $90,000
o Residual theory
Net Income = Operating margin – (Interest expense + Dividends preferred stock)
= $300,000 – ($80,000 + $30,000)
= $300,000 - $110,000
= $190,000

2. Would any of your answers change if the preferred stock is convertible at any time at the ratio of 2 preferred shares for 1 share of common stock?
With the figures provided if there were a 2 for 1 split, then the price of the stock would go from $5/share to $2.50/share, also the outstanding shares would be 40,000 instead of 20,000. The dividends declared on this split would be the same $100,000, although the par value would decrease in half from $500,000 to $250,000. So with that being said, the dividends declared on 6% preferred stock would now be $15,000.
So, to answer the question, yes there would be changes to some of my answers.
The Entity theory (unorthodox view) and the Residual theory would change. The unorthodox view of the Entity theory would give us a net income of $105,000. The Residual theory would give us a net income of $205,000.

References:

Dodd, J.L., Tearney, M.G., and Wolk, H.I. (2004). Accounting Theory: Conceptual Issues in a Political and Economic. 6th Ed. Thomson South-Western. Mason,... [continues]

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