Chapter 12, Problem 7E

a.

To determine

Journalize the stock related transactions in the books of Company HM.

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Journalize the stock related transactions in the books of Company HM.

Transaction on April 30:

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
April	30	Memorandum entry: A 2-for-1 stock split increased the number of shares of common stock outstanding from 1,000,000 shares to 2,000,000 shares and reduced the par value from $1 to $0.50 per share. The 1,000,000 new shares were distributed.

Table (1)

Working Notes:

Compute the number of shares after stock split on April 30.

$\begin{array}{c}\begin{array}{l}\text{Total number of shares }\\ \text{after stock-split}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Total number of shares outstanding }\\ \text{before stock split × Stock split}\end{array}\right)\\ \text{= 1,000,000 shares × }\frac{2}{1}\\ \text{= 2,000,000 shares}\end{array}$ (1)

Compute the par value of shares after stock split.

$\begin{array}{c}\text{Par value of shares after stock split = }\frac{\text{Par value before stock split}}{\text{Stock split rate}}\\ \text{= }\frac{\text{\$1}}{\frac{2}{1}}\\ =\$1\times \frac{1}{2}\\ \text{= \$0}\text{.50}\end{array}$   (2)

Transaction on June 1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
June	1	Dividends			1,200,000
			Dividends Payable			1,200,000
		(Record declaration of dividends)

Table (2)

Description:

• Dividends is a stockholders’ equity account. Since the dividends are declared, stockholders’ equity is decreased, and a decrease in equity account is debited.
• Dividends Payable is a liability account. Since the liability to pay dividends increased, liability increased, and an increase in liability is credited.

Working Notes:

Compute the amount of cash dividends on common stock.

$\begin{array}{c}\text{Cash dividends}=\left\{\begin{array}{l}\text{Number of common shares outstanding }\times \\ \text{Dividend per share}\end{array}\right\}\\ =2,000,000\text{ shares}\times \$0.60\text{ per share}\\ =\$1,200,000\end{array}$ (3)

Note: Refer to Equation (1) for value and computation of number of shares outstanding.

Transaction on July 1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
July	1	Dividends Payable			1,200,000
			Cash			1,200,000
		(Record payment of cash dividends)

Table (3)

Description:

• Dividends Payable is a liability account. Since the liability to pay dividends has been paid off, liability decreased, and a decrease in liability is debited.
• Cash is an asset account. The amount is decreased because cash is paid as dividends, and a decrease in assets should be credited.

Note: Refer to Equation (3) for value and computation of cash dividends.

Transaction on August 1:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
August	1	Retained Earnings			1,900,000
			Stock Dividends to Be Distributed			50,000
			Additional Paid-in Capital: Stock Dividends			1,850,000
		(Record declaration of stock dividends)

Table (4)

Description:

• Retained Earnings is a stockholders’ equity account. Since the dividends are declared, stockholders’ equity is decreased, and a decrease in equity account is debited.
• Stock Dividends to Be Distributed is a stockholders’ equity account. Since common stock is declared to be distributed as stock dividends at par value, equity value is increased. An increase in equity is credited.
• Additional Paid-in Capital: Stock Dividends is a stockholders’ equity account. Since the stock is issued in excess of par value, equity value is increased. An increase in equity is credited.

Working Notes:

Compute the number of shares to be distributed as stock dividends.

$\begin{array}{c}\text{Stock dividend shares = }\left\{\begin{array}{l}\text{Number of shares outstanding }\times \\ \text{Stock dividend percentage}\end{array}\right\}\\ \text{= 2,000,000 shares× 5\%}\\ \text{=559,500 shares× 5\%}\\ \text{= 100,000 shares}\end{array}$ (4)

Note: Refer to Equation (1) for value and computation of number of shares outstanding.

Compute amount of retained earnings distributable for stock dividends (Refer to Equation (4) for stock dividend shares value).

$\begin{array}{c}\text{Retained earnings = Stock dividend shares }\times \text{ Market value per share}\\ \text{= 100,000 shares × \$19}\\ \text{= \$1,900,000}\end{array}$ (5)   

Compute the amount of stock dividends to be distributed (Refer to Equation (4) for stock dividend shares value).

$\begin{array}{c}\begin{array}{l}\text{Stock dividends to be }\\ \text{distributed value}\end{array}\}\text{ = Stock dividend shares }\times \text{ Par value of stock}\\ \text{= 100,000 shares × \$0}\text{.50}\\ \text{= \$50,000}\end{array}$ (6)

Compute additional paid-in capital (Refer to Equations (5) and (6) for retained earnings and stock dividends to be distributed value).

$\begin{array}{c}\text{Additional paid-in capital = Retained earnings –Stock dividends to be distributed}\\ \text{= \$1,900,000 – \$50,000}\\ \text{= \$1,850,000}\end{array}$

Transaction on September 10:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
September	10	Stock Dividends to Be Distributed			50,000
			Common Stock			50,000
		(Record distribution of stock dividends)

Table (5)

Description:

• Stock Dividends to Be Distributed is a stockholders’ equity account. Since common stock is issued due to declaration of stock dividends, the value is transferred to common stock, the equity value is decreased. A decrease in equity is debited.
• Common Stock is a stockholders’ equity account. Since common stock is issued, equity value is increased. An increase in equity is credited.

Note: Refer to Equation (6) for value and computation of stock dividends distributable value.

b.

To determine

Compute the number of shares outstanding for Company HM at the end of the year.

Explanation of Solution

Compute the number of shares outstanding for Company HM at the end of the year.

$\begin{array}{c}\begin{array}{l}\text{Number of shares }\\ \text{outstanding}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Number of shares at January 1+}\\ \text{Number of shares distributed as stock split on April 30 +}\\ \text{Number of shares distributed as stock dividend on September 10+}\end{array}\right\}\\ \text{=}\left(\text{1,000,000+1,000,000+100,00}\right)\text{shares}\\ \text{= 2,100,000 shares}\end{array}$

Conclusion

Thus, the number of shares outstanding for Company HM at the end of the year are 2,100,000 shares.

c.

To determine

Indicate the par value of capital stock of Company HM at the end of the year.

Explanation of Solution

Par value: The corporation charter assigns and allocates the dollar value for its share which is referred to as par value.

Par value of Company HM: The par value of Company HM at the end of the year is $0.50, after stock split (Refer to Equation (2) for computation).

Conclusion

Thus, the par value of capital stock of Company HM at the end of the year is $0.50.

d.

To determine

Indicate the effect of stock split, declaration and payment of cash dividends, and declaration and distribution of stock dividend on stockholders’ equity.

Explanation of Solution

Stock splits: Stock split is the increase in number of shares due to splitting or decreasing par value of each share.

Cash dividends: This is the amount of cash distributed to stockholders by a company out its earnings, according to their proportion of shares invested in the company.

Stock dividends: Stock dividends are the number of shares issued by a company to the existing shareholders in a proportion equal to the number of shares owned by each shareholder, based on a stock dividend percentage.

Effect of stock split on stockholders’ equity: Stock splits are the number of shares issued by reducing the par value of shares. This adds to the number of shares outstanding. Stock splits has no effect on the shareholders’ equity because the number of shares would increase as a result of reduction in par value to maintain the common share capital unchanged. Thus, no effect on stockholders’ equity.

Effect of declaration of cash dividends on stockholders’ equity: The declaration of cash dividend decreases Dividends account, a stockholders’ equity account and increases Dividend Payable account, a current liability account. Cash dividends are the amount of cash paid as dividends to the stockholders. So, the amount of cash reduces and the same amount is deducted from the retained earnings, thus, reducing the stockholders’ equity amount.

Effect of payment of cash dividends on stockholders’ equity: The payment of cash dividend decreases both Dividend Payable account, a current liability account, and Cash account, a current asset account. Thus, there is no effect on stockholders’ equity.

Effect of declaration of stock dividend on stockholders’ equity: When stock dividends are declared, the Retained Earnings account is decreased, Stock Dividends to Be Distributed account is increased, and Additional Paid-in Capital account is increased. Since, all these are stockholders’ equity accounts, the values are increased and decreased by the same amounts, and hence, the net effect is nil on stockholders’ equity.

Effect of distribution of stock dividend on stockholders’ equity: A stock dividend is distribution of additional shares to the stockholder by decreasing the retained earnings value and increasing the contributed capital value by the same amount. Hence, stockholders’ equity remains the same.