Final answer:
The true/false question is related to the accounting treatment of the conversion of preferred stock to common stock. The statement is false as any excess of the common stock's par value over the book value of the converted preferred stock is credited to additional paid-in capital, not debited from retained earnings.
Step-by-step explanation:
The question at hand comes from the subject of accounting and deals with the treatment of convertible preferred stock when it is exercised for common stock. According to generally accepted accounting principles (GAAP), if the par value of the common stock issued exceeds the book value of the preferred stock, this would typically lead to an adjustment within the stockholders’ equity section, but not a debit to retained earnings. Instead, the additional paid-in capital (APIC) account is credited for any difference between the par value of common stock and the book value of the preferred stock converted. Hence, the correct answer is B. False. The retained earnings would not be directly affected in such a transaction.
When accounting for the exercise of convertible instruments, the focus is on preserving the equity structure of the balance sheet. GAAP aims to reflect the economic substance of transactions rather than just their legal form. In this case, converting preferred stock to common stock doesn’t result in profits or losses but is merely an equity restructuring. Thus, it would not be appropriate to debit retained earnings, which represents the cumulative income that has been retained by the company rather than distributed to shareholders as dividends.