Chapter 11, Problem 11SP

1.

To determine

Explain the difference between the two types of stock and give suggestion to Person K that which type of stock is most appropriate for her to issue. 

Explanation of Solution

Differences between the two types of stocks are:

Common Stock	Preferred Stock
It refers to the ordinary shares that represents the differential right of ownership of the stockholders.	It refers to the shares that represent the preferential right of ownership of the stockholders.
The stockholders have the voting rights.	The stockholders do not have voting rights.
They have lesser claim on company’s assets and earnings on liquidation.	They have greater claim on company’s assets and earnings on liquidation.
The dividend payments are not guaranteed and are paid after the payment made to the preferred stockholders.	The dividend payments are guaranteed as the amount is paid at regular intervals and any unpaid dividends in previous year are paid in the future years.

Table (1)

Person K can issue preferred stock to Person T, so that all voting powers can be retained by Person K.

2.

To determine

Prepare the journal entry to record the issuance of the preferred stock for cash.

Explanation of Solution

Preferred stock: The stock that provides a fixed amount of return (dividend) to its stockholder before paying dividends to common stockholders is referred as preferred stock.

Par value: It refers to the value of a stock that is stated by the corporation’s charter. It is also known as face value of a stock.

Record the issuance of preferred stock for cash.

Date	Account Title and Explanation	Post Ref.	Debit	Credit
	Cash  (1)		$5,000
	Preferred stock			$5,000
	(To record 50, $100 par value preferred stock issued at $par)

Table (2)

Working note:

Calculate the value of preferred stock.

$\begin{array}{c}\text{Preferred stock value}=\left(\begin{array}{l}\text{Number of preferred shares issued}\times \\ \text{Par value per share}\end{array}\right)\\ =\text{100 shares}\times \text{\$50 per share}\\ \text{=\$5,000}\end{array}$ (1)

Description:

• Cash is an asset account. The amount is increased, because cash is received upon stock issued. Therefore, debit Cash account with $5,000.
• Preferred Stock is a stockholders’ equity account and the amount is increased due to issuance of preferred stock. Therefore, credit Preferred Stock account with $5,000.

Note: Paid in capital in excess of par-preferred value is not recorded, since it is not given that how much amount of cash is received upon stock issuance. But, it is simply given that stock is issued for cash; hence it is assumed that the stock is issued at par.

3.

To determine

Discuss the difference between a cash dividend and a stock dividend, and show the effect of issuing a 10% stock dividend for common stock.

Explanation of Solution

Cash dividends: The amount of cash provided by a corporation out of its distributable profits to its shareholders as a return for the amount invested by them is referred as cash dividends.

Stock Dividends:  It refers to the payment of the dividend to its shareholders by the corporation in the form of shares rather than cash is referred as stock dividend.

Effects of cash dividends:

• It decreases assets as cash is paid as dividends to stockholders.
• It decreases retained earnings as the capital available for future growth reduces.
• It decreases the total stockholders’ equity as retained earnings is a component of stockholders’ equity, and it reduces.

Effects of stock dividends:

• It has no effect on total assets as it does not involve cash for dividend distribution.
• It increases the paid-in capital as the dividend declared is transferred to the additional paid-in capital that includes the value of the stock in excess of par value.
• It reduces the retained earnings as the total amount dividend declared is deducted from the retained earnings and transferred to the paid-in capital.
• Both the retained earnings and paid-in capital are the components of stockholders’ equity.
• Since retained earnings reduce while the paid-in capital increases by the same amount, it does not affect the total amount of stockholders’ equity.

Effect of issuing a 10% stock dividend:

• Issuance of 10% stock dividend is a small stock dividend. This will increase the paid in capital of common stock and decrease the retained earnings by the same amount, but small stock dividend will be issued based on the market value of the common stock.

4.

To determine

Provide journal entry to record the payment of the cash dividends.

Explanation of Solution

Provide journal entry to record the payment of the cash dividends.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
		Cash Dividends (4)		1,300
		Cash			1,300
		(To record payment of cash dividends)

Table (3)

Working Note:

Compute the amount of cash dividends declared for common stockholders.

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{dividends for}\\ \text{common stockholders}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of shares outstanding}\times \\ \text{Dividend per share}\end{array}\right\}\\ \text{= 500 shares}\times \text{\$2}\\ \text{= \$1,000}\end{array}$ (2)

Compute the amount of cash dividends declared for preferred stockholders.

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{dividends for}\\ \text{preferred stockholders}\end{array}\}\text{= }\left\{\begin{array}{l}\text{Number of shares outstanding}\times \\ \text{Dividend per share}\end{array}\right\}\\ \text{= 50 shares}\times \text{\$6}\\ \text{= \$300}\end{array}$ (3)

Compute the total amount of cash dividend paid.

$\begin{array}{c}\text{Total cash dividend paid = }\left[\begin{array}{l}\text{Cash}\text{dividends for preferred stockholders}+\\ \text{Cash}\text{dividends for common stockholders}\end{array}\right]\\ \text{= }\$300+\$1,000\\ \text{= \$1,300}\end{array}$ (4)

• Cash Dividends is a temporary stockholders’ equity account. The account is debited as the cash dividends are declared and eventually be transferred to Retained Earnings account. Therefore, debit Cash Dividends account with $1,300.
• Cash is an asset account and the amount is decreased because cash is paid. Therefore, credit Cash account with $1,300.

5.

To determine

Prepare a statement of retained earnings for the month of August 2016 and the stockholders’ equity section of the balance sheet as of August 31, 2016.

Explanation of Solution

Statement of Retained Earnings:

This is a financial statement that determines the amount of earnings kept by the business as retained earnings at the end of the financial year. This statement shows the retained earnings held by the business at the beginning and at the end of the financial year, amount of net income earned during the year and the amount of dividend declared to the shareholder for the year.

Prepare a statement of retained earnings for the month of August 2016.

Statement of retained earnings For the month ended August 2016
Particulars	Amount
Retained earnings, July 31 2016	$15,000
Add: Net income	$1,500
	$16,500
Less: Cash dividend declared	$1,300
Retained earnings, August 31 2016	$15,200

Table (4)

Stockholders’ Equity Section: It is refers to the section of the balance sheet that shows the available balance of each stockholder’s equity account as on reported date at the end of the financial year.

Prepare stockholders’ equity section of the balance sheet as of August 2016.

Stockholders’ equity section (Balance sheet)
As of August 31, 2016
Stockholders’ equity:
Paid-in Capital:
6% cumulative preferred stock, $100 par value, 50 shares issued and outstanding	$5,000
Common stock, $1 par value, 5,000 shares authorized, 500 shares issued and outstanding	$500
Paid-in capital in excess of par value-Common stock	$9,500
Total paid-in capital	$15,000
Retained earnings	15,200
Total stockholders’ equity	$30,200

Table (5)