Chapter 11, Problem 2E

Reporting Stockholders' Equity and Determining Dividend Policy

Incentive Corporation was authorized to issue 12,000 shares of common stock, each with a $1 par value. During its first year, the following selected transactions were completed:

1. a. Issued 6,000 shares of common stock for cash at $20 per share.
2. b. Issued 2,000 shares of common stock for cash at $23 per share.

Required:

1. 1. Show the effects of each transaction on the accounting equation.
2. 2. Give the journal entry required for each of these transactions.
3. 3. Prepare the stockholders’ equity section as it should be reported on the year-end balance sheet. At year-end, the accounts reflected a profit of $100.
4. 4. Incentive Corporation has $30,000 in the company’s bank account. What is the maximum amount of cash dividends the company can declare and distribute?

To determine

To show: The effects of each transaction on the accounting equation.

Explanation of Solution

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\boxed{\text{Assets}=\text{Liabilities}+\text{Stockholders' equity}}$

1. a. Issued 6,000 shares of common stock for cash at $20per share.

	Assets		Liabilities	Stockholders’ equity
a.	Cash	+120,000(1)	No effect	Common stock Additional paid-in capital common	+6,000(2) +114,000(3)

Table (1)

• There is an increase in the asset (cash) by $120,000.
• There is an increase in the stockholders’ equity (Common stock) by $6,000 and increase in the additional paid in capital by $114,000.

Working note:

Calculate the amount of cash:

$\begin{array}{c}\text{Cash}=\text{Number of shares issued}\times \text{Cost price per share}\\ =6,000\text{Shares}\times \$20\text{Per share}\\ =\$120,000\end{array}$ (1)

Calculate the amount of common stock:

$\begin{array}{c}\text{Common stock}=\text{Number of shares}\times \text{par value}\\ =6,000\text{ Shares}\times \$1\text{Per share}\\ =\$6,000\end{array}$ (2)

Calculate the amount for additional paid in capital:

$\begin{array}{c}\text{Additional paid in capital}=\text{Number of shares}\times \left(\text{Cost price}-\text{Par value}\right)\\ =6,000\text{Shares}\times \left(\$20-\$1\right)\\ =\text{\$114,000}\end{array}$

1. b. Issued 2,000 shares of common stock for cash at $23per share.

	Assets		Liabilities	Stockholders’ equity
a.	Cash	+46,000(4)	No effect	Common stock Additional paid-in capital common	+2,000(5) +44,000(6)

Table (1)

• There is an increase in the asset (cash) by $46,000.
• There is an increase in the stockholders’ equity (Common stock) by $2,000 and increase in the additional paid in capital by $44,000.

Working note:

Calculate the amount of cash:

$\begin{array}{c}\text{Cash}=\text{Number of shares issued}\times \text{Cost price per share}\\ =2,000\text{Shares}\times \$23\text{Per share}\\ =\$46,000\end{array}$ (4)

Calculate the amount of common stock:

$\begin{array}{c}\text{Common stock}=\text{Number of shares}\times \text{par value}\\ =2,000\text{ Shares}\times \$1\text{Per share}\\ =\$2,000\end{array}$ (5)

Calculate the amount for additional paid in capital:

$\begin{array}{c}\text{Additional paid in capital}=\text{Number of shares}\times \left(\text{Cost price}-\text{Par value}\right)\\ =2,000\text{Shares}\times \left(\$23-\$1\right)\\ =\text{\$44,000}\end{array}$ (6)

To determine

To prepare: The journal entry for the given transactions.

Explanation of Solution

Journal:

Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Prepare the journal entries:

1. a. Issued 6,000 shares of common stock for cash at $20 per share

Date		Account Title and Explanation	Debit ($)	Credit ($)
	a.	Cash $\left(6,000\text{Shares}\times \$20\text{Per share}\right)$	120,000
		Common stock $\left(6,000\text{Shares}\times \$1\text{Par value}\right)$		6,000
		Additional paid in capital, common stock $\left(6,000\text{Shares}\times \$19\left[\$20-\$1\right]\right)$		114,000
		(To record the issuance of common stock to investors at premium)

Table (1)

• Cash is an asset. There is an increase in the cash. Hence, debit cash account with $120,000.
• Common stock is a component of stockholders’ equity. There is an increase in the common stock which increases the stockholders’ equity. Hence, credit stockholders’ equity with $6,000.
• Additional paid in capital (common stock). There is an increase in the common stock which increases the stockholders’ equity. Hence, credit additional paid in capital with $114,000.

1. b. Issued 2,000 shares of common stock for cash at $23 per share

Date		Account Title and Explanation	Debit ($)	Credit ($)
	a.	Cash $\left(2,000\text{Shares}\times \$23\text{Per share}\right)$	46,000
		Common stock $\left(2,000\text{Shares}\times \$1\text{Par value}\right)$		2,000
		Additional paid in capital, common stock $\left(2,000\text{Shares}\times \$22\left[\$23-\$1\right]\right)$		44,000
		(To record the issuance of common stock to investors at premium)

Table (2)

• Cash is an asset. There is an increase in the cash. Hence, debit cash account with $46,000.
• Common stock is a component of stockholders’ equity. There is an increase in the common stock which increases the stockholders’ equity. Hence, credit stockholders’ equity with $2,000.
• Additional paid in capital (common stock). There is an increase in the common stock which increases the stockholders’ equity. Hence, credit additional paid in capital with $44,000.

To determine

To prepare: The stockholders’ equity section of the balance sheet at 31^st December.

Explanation of Solution

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 the stockholders’ equity section of the balance sheet:

Balance sheet (Partial)
Stockholders' equity -December 31,2013
Particulars	Amount($)	Amount($)
Contributed capital:
Common stock, par $1, authorized 12,000 shares, Outstanding shares $\left(6,000\text{Shares}+2,000\text{Shares}\right)$	8,000
Additional paid in capital, common stock $\left[\$114,000+\$44,000\right]$	$158,000
Total contributed capital	$166,000
Retained earnings	$100
Total stockholders' equity		$166,100

Table (3)

To determine

The maximum amount of cash dividend the company can declare and distribute.

Explanation of Solution

Stock Dividends:

It refers to the payment of dividends by a company to its existing shareholders, in the form of additional shares rather than cash. Stock dividends are paid, when there is inadequate cash available in the company.

The company can declare and distribute $100 as the maximum dividend and it have only $100 as the retained earnings.