[jombe]

I got this question from NINJA MCQ – REG.

Drain Corp. has two classes of stock—100,000 shares of authorized, issued, and outstanding voting common stock and 10,000 shares of authorized, issued, and outstanding nonvoting 5% cumulative, nonparticipating preferred stock with a face value of $100 per share. In 20X1, Drain’s officers and directors intentionally allowed pollutants to be discharged by Drain’s processing plant. These actions resulted in Drain having to pay penalties. Solely as a result of the penalties, no dividends were declared for the years ended December 31, 20X1, and December 31, 20X2. The total amount Drain paid in penalties was $1,000,000. In 20X2, Drain was able to recover the full amount of the penalties from an insurance company that had issued Drain a business liability policy. Drain’s directors refused to use this money to declare a dividend and decided to hold the $1,000,000 in a special fund to pay future bonuses to officers and directors.

Please choose the best answer to complete the following statement.

If the $1,000,000 was distributed to the shareholders in 20X2, the distribution would be characterized as:

A. a cash dividend.

B.an illegal dividend. -> INCORRECT

C.a property dividend.

D.a stock dividend.

so…. i thought “Solely as a result of the penalties, no dividends were declared for the years ended December 31, 20X1, and December 31, 20X2.” + “If the $1,000,000 was distributed to the shareholders in 20X2,” would mean the corporation distributed $1,000,000 without formal BOD declaration, thus “illegal div’d” would be the closest answer.

correct answer is “cash div’d” and explanation i got is “A distribution of cash to the shareholders would be a cash dividend. A stock dividend entails the issuance of new shares of stock. A property dividend would entail the distribution of property other than cash.”.

Can anyone shed some light on my confusion? i mean, doesn’t BOD have to declare div’d in order for it to be valid?

FAR - 94 (10/4/15), Local Prep Online Lectures, BISK & NINJA MCQ
AUD - 99 (1/19/16), Local Prep Online Lectures, BISK & NINJA MCQ
REG - 96 (4/19/16), Local Prep Online Lectures, BISK & NINJA MCQ
BEC - 91 (7/19/16), Local Prep Online Lectures, BISK & NINJA MCQ

581 days of listening to lectures, reading texts & 10,000+ MCQs...

[EuroAddict]

I think you're reading too much into the Q.

-----------------------------
BEC - 77, 03/2015 (first try)
FAR - 79, 05/2015 (second try)
REG - 83, 12/2015 (first try)
AUD - 84, 03/2015 (first try)

I got 99 problems but the CPA ain't one.

[jombe]

lol i know i know… i would say the same thing if i passed all 4 exams too… 🙁

FAR - 94 (10/4/15), Local Prep Online Lectures, BISK & NINJA MCQ
AUD - 99 (1/19/16), Local Prep Online Lectures, BISK & NINJA MCQ
REG - 96 (4/19/16), Local Prep Online Lectures, BISK & NINJA MCQ
BEC - 91 (7/19/16), Local Prep Online Lectures, BISK & NINJA MCQ

581 days of listening to lectures, reading texts & 10,000+ MCQs...

[SteadyGrind]

In my opinion, there is nothing illegal about the dividend. The company actually paid the penalty and was reimbursed by their insurance company. Furthermore, the company is not obligated to pay a dividend in any year, and (in this case) they chose to put the penalty reimbursement in a fund to pay future bonuses. Getting back to the call of the question, if the company “hypothetically” distributed the funds to shareholders, it would be a normal cash dividend. It would be an illegal dividend if the company were under-capitalized and issued a cash dividend (or something like that). Hope this helps!

BEC:83
FAR:75! x3
AUD:79
REG:75 x2

[NebCPA]

An illegal dividend is a dividend that is in violation of a corporate charter or of state laws. Generally speaking, state laws prohibit dividends payments from a surplus capital account instead of earnings.

The reason why you are reading too much into the question is because you are assuming things. The question does not state there is a BOD. The question does not state if or what corporate charters exist. The question does not state that if a BOD exists, then they need to approve dividends. This corporation could be 4 college buddies who formed the company: each is a director or officer and they are all shareholders, holding 100% of the issued stock. Or it could be a publicly traded company with 1M investors – we really have no idea.

What we know: the company raised at least $1M is capital by issuing stock. The company had $1M is penalties, which it paid. The company then received $1M in insurance proceeds.

The question is a hypothetical: if a dividend would have been paid, then what would it have been classified as?

I think we can easily eliminate the stock and property dividend answers because the question does not state that stock or property, other than cash, would have been paid. That leaves us with 2 options: cash dividend or illegal.

As stated above, we don’t know that the dividend is in violation of any corporate charters. To think or say so would be assuming something that is not stated. We then look at whether the dividend would come from an excess capital account – the answer here is no. The company raised $1M, spent $1M, and then earned $1M which will flow through retained earnings – the divided would be paid from earnings not an excess capital account. The company may have had other operations, may have been profitable or operated at a loss, but honestly, we don’t know and we don’t care – it’s irrelevant to the question.

The dividend if it were issued, would have been cash and would have come from current earnings – that by definition is a cash dividend.

[Author]

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