Exercises: Chapter 10A

SHORT-ANSWER QUESTIONS, EXERCISES, AND PROBLEMS

➢  Cite the major advantages of the corporate form of business organization and indicate why each is considered an advantage.

➢  What is meant by the statement that corporate income is subject to double taxation? Cite several other disadvantages of the corporate form of organization.

➢  Why is Organization Expense not a good title for the account that records the costs of organizing a corporation? Could you justify leaving the balance of an Organization Costs account intact throughout the life of a corporation?

➢  What are the basic rights associated with a share of capital stock if there is only one class of stock outstanding?

➢  Explain the purpose or function of: (a) the stockholders’ ledger, (b) the minutes book, (c) the stock-transfer agent, and (d) the stock registrar.

➢  What are the differences between par value stock and stock with no-par value?

➢  Corporate capital stock is seldom issued for less than par value. Give two reasons why this statement is true.

➢  Explain the terms liquidation value and redemption value.

➢  What are the meanings of the terms stock preferred as to dividends and stock preferred as to assets?

➢  What do the terms cumulative and noncumulative mean in regard to preferred stock?

➢  What are dividends in arrears, and how should they be disclosed in the financial statements?

➢  A corporation has 1,000 shares of 8 per cent, $ 200 par value, cumulative, preferred stock outstanding. Dividends on this stock have not been declared for three years. Is the corporation legally liable to its preferred stockholders for these dividends? How should this fact be shown in the balance sheet, if at all?

➢  Explain why a corporation might issue a preferred stock that is both convertible into common stock and callable.

➢  Explain the nature of the account entitled Paid-In Capital in Excess of Par Value. Under what circumstances is this account credited?

➢  What are the two main elements of stockholders’ equity in a corporation? Explain the difference between them.

➢  Name several sources of paid-in capital. Would it suffice to maintain one account called Paid-In Capital for all sources of paid-in capital? Why or why not?

➢  Does accounting for treasury stock resemble accounting for an asset? Is treasury stock an asset? If not, where is it properly shown on a balance sheet?

➢  What are some possible reasons for a corporation to reacquire its own capital stock as treasury stock?

Exercises

Exercise A Kelly Green and Rose Violet form a partnership.  Kelly contributes $130,000 cash and Rose contributes equipment worth $20,000 and a building worth $150,000.  The building has a mortgage of $70,000 that will now be paid by the partnership.  Write the required journal entries for each partner’s investment.

Exercise B  Partner Z withdraws cash of $25,000 and Partner Y withdraws $18,000.  Write the journal entries required to record each partner’s withdrawal.

Exercise C  Partner Z withdraws cash of $25,000 and Partner Y withdraws $18,000.  Write the journal entries required to record each partner’s withdrawal.

Exercise D  Sonny Shade, Roni Rain, and Chloe Cloud form the Stormy Season partnership.  Sonny has a capital balance of $200,000; Roni $300,000; and Chloe $600,000.  Income and loss allocated based on (1) salaries given to Sonny $70,000, Roni $40,000 and Chloe $20,000; (2) 10% interest based on their capital balances; (3) remainder divided equally.  Calculate the amount of net income to be allocated to each partner if net income is $255,000.

Exercise E  Assume the same facts as in Exercise ? but instead of net income there is a net loss of $45,000.  Calculate the amount of net loss to be allocated to each partner and the required journal entry to close income summary.

Exercise F Gordon Company issued 10,000 shares of common stock for $ 1,120,000 cash. The common stock has a par value of $ 100 per share. Give the journal entry for the stock issuance.

Exercise G Thore Company issued 30,000 shares of $ 20 par value common stock for $ 680,000. What is the journal entry for this transaction? What would the journal entry be if the common stock had no-par or stated value?

Exercise H Li & Tu, Inc., needed land for a plant site. It issued 100 shares of $ 480 par value common stock to the incorporators of their corporation in exchange for land, which cost $ 56,000 one year ago. Experienced appraisers recently valued the land at $ 72,000. What journal entry would be appropriate to record the acquisition of the land?

Exercise I Smart Corporation owes a trade creditor $ 30,000 on open account which the corporation does not have sufficient cash to pay. The trade creditor suggests that Smart Corporation issue to him 750 shares of the $ 24 par value common stock, which is currently selling on the market at $ 40. Present the entry or entries that should be made on Smart Corporation’s books.

Exercise J Why would a law firm ever consider accepting stock of a new corporation having a total par value of $ 320,000 as payment in full of a $ 480,000 bill for legal services rendered? If such a transaction occurred, give the journal entry the issuing company would make on its books.

Exercise K Kelly Company had outstanding 50,000 shares of $ 20 stated value common stock, all issued at $ 24 per share, and had retained earnings of $ 800,000. The company reacquired 2,000 shares of its stock for cash at book value from the widow of a deceased stockholder.

  1. Give the entry to record the reacquisition of the stock.
  2. Give the entry to record the subsequent reissuance of this stock at $ 50 per share.
  3. Give the entry required if the stock is instead reissued at $ 30 per share and there were no prior treasury stock transactions.

 

Problems

Problem A  LMN Partnership consists of capital balances for Partner L $425,000, Partner M $150,000 and Partner N $325,000.  Calculate the amount of net income (or loss) to be allocated to each partner and the required journal entry to close income summary for each independent situation below.  Net income for the year is $240,000.

  1. Net Income is divided equally
  2. Net Income is divided based on a percentage of capital balance
  3. Net income is allocated giving salaries of $50,000 to Partner L and $30,000 to Partner N. Each partner receives 10% of their capital balance and any remainder is divided equally.
  4. Assume the same facts as 3 above but there is a net loss of $4,000 instead of net income.

Problem B  The PQ partnership is not going well and the partners have decided to liquidate the business.  The partners share income and loss in a ratio of 2:1.  The balance sheet for the business is listed below:

PQ Company
Balance Sheet
Assets Liabilities and Equity
Cash                   50,000  Accounts Payable                  500,000
Building                800,000  Partner P, Capital                  170,000
 Partner Q, Capital                180,000
Total Assets                850,000  Total Liab. and Equity                  850,000

 

Prepare the liquidation schedule and all required journal entries for the liquidation assuming the building is sold for $650,000 cash.

Problem C  The bookkeeper of Hart Company has prepared the following incorrect statement of stockholders’ equity for the year ended 2009 December 31:

Stockholders’ equity:
  Paid-In Capital:
   Preferred stock – 6%, cumulative (8,000 shares) $1,003,200
   Common stock – 50,000 shares 2,856,000
    Total paid-in capital $3,859,200
  Retained earnings 1,636,800
     Total stockholders’ equity $5,496,000

The authorized stock consists of 12,000 shares of preferred stock with a $ 120 par value and 75,000 shares of common stock, $ 48 par value. The preferred stock was issued on two occasions: (1) 5,000 shares at par, and (2) 3,000 shares at $ 134.40 per share. The 50,000 shares of common stock were issued at $ 62.40 per share. Five thousand shares of treasury common stock were reacquired for $ 264,000. The bookkeeper deducted the cost of the treasury stock from the Common Stock account.

Prepare the correct stockholders’ equity section of the balance sheet at 2009 December 31.

Problem D On 2008 December 27, Glade Company was authorized to issue 250,000 shares of $ 24 par value common stock. It then completed the following transactions:

2009

Jan. 14 Issued 45,000 shares of common stock at $ 30 per share for cash.

29 Gave the promoters of the corporation 25,000 shares of common stock for their services in organizing the company. The board of directors valued these services at $ 744,000.

19 Exchanged 50,000 shares of common stock for the following assets at the indicated fair market values:

Land $ 216,000
Building 528,000
Machinery 720,000
  1. Prepare general journal entries to record the transactions.
  2. Prepare the balance sheet of the company as of 2009 March 1.

Problem E In the corporate charter that it received on 2009 May 1, Norris Company was authorized to issue 15,000 shares of common stock. The company issued 1,000 shares immediately for $ 82 per share, cash.

On July 2, the company issued 100 shares of stock to a lawyer to satisfy a $ 8,400 bill for legal services rendered in organizing the corporation.

On July 5, the company issued 1,000 shares to the principal promoter of the corporation in exchange for a patent. Another 200 shares were issued to this same person for costs incurred and services rendered in bringing the corporation into existence. The market value of the stock was $ 84 per share.

  1. Set up T-accounts, and post these transactions. Then prepare a balance sheet for the Norris Company as of 2009 July 5, assuming the authorized stock has a par value of $ 75 per share.
  2. Repeat part (a) for the stockholders’ equity accounts, and prepare the stockholders’ equity section of the July 5 balance sheet assuming the stock authorized has no par value but has a $ 30 per share stated value.
  3. Repeat part (a) for the stockholders’ equity accounts assuming the stock authorized has neither par nor stated value. Prepare the stockholders’ equity section of the balance sheet.

Problem F On 2009 May 1, Farmington Company received a charter that authorized it to issue:

  • 4,000 shares of no-par preferred stock to which a stated value of $ 12 per share is assigned. The stock is entitled to a cumulative dividend of $ 9.60, convertible into two shares of common stock, callable at $ 208, and entitled to $ 200 per share in liquidation.
  • 1,500 shares of $ 400 par value, $ 20 cumulative preferred stock, which is callable at $ 420 and entitled to $ 412 in liquidation.
  • 60,000 shares of no-par common stock to which a stated value of $ 40 is assigned.

May 1 All of the $ 9.60 cumulative preferred was issued at $ 204 per share, cash.

2 All of the $ 20 cumulative preferred was exchanged for merchandise inventory, land, and buildings valued at $ 128,000, $ 160,000, and $ 425,000, respectively.

3 Cash of $ 15,000 was paid to reimburse promoters for costs incurred for accounting, legal, and printing services. In addition, 1,000 shares of common stock were issued to the promoters for their services. The value of all of the services (including those paid in cash) was $ 55,000.

  1. Prepare journal entries for these transactions.
  2. Assume that retained earnings were $ 200,000. Prepare the stockholders’ equity section of the 2009 May 31, balance sheet.

Problem G On 2008 January 2, the King Company received its charter. It issued all of its authorized 3,000 shares of no-par preferred stock at $ 104 and all of its 12,000 authorized shares of no-par common stock at $ 40 per share. The preferred stock has a stated value of $ 50 per share, is entitled to a basic cumulative dividend of $ 6 per share, is callable at $ 106 beginning in 2010, and is entitled to $ 100 per share plus cumulative dividends in the event of liquidation. The common stock has a stated value of $ 10 per share.

On 2009 December 31, the end of the second year of operations, retained earnings were $ 90,000. No dividends have been declared or paid on either class of stock.

Prepare the stockholders’ equity section of King Company’s 2009 December 31, balance sheet.

Alternate problems

Alternate problem A The trial balance of Dex Corporation as of 2009 December 31, contains the following selected balances:

Notes payable (17%, due 2011 May 1) $4,000,000
Allowance for uncollectible accounts 60,000
Common stock (without par value, $20 stated value; 300,000 shares authorized, issued, and outstanding)    6,000,000
Retained earnings, unappropriated 500,000
Dividends payable (in cash, declared December 15 on preferred stock) 14,000
Appropriation for pending litigation 600,000
Preferred stock (6%, $200 par value; 3,000 shares authorized, issued, and outstanding) 600,000
Paid-In Capital – Donations 400,000
Paid-In Capital in Excess of Par Value – Preferred 10,000

Present the stockholders’ equity section of the balance sheet as of 2009 December 31.

Alternate problem B On 2009 January 1, Cowling Company was authorized to issue 500,000 shares of $ 5 par value common stock. It then completed the following transactions:

2009

Jan. 14 Issued 90,000 shares of common stock at $ 24 per share for cash.

29 Gave the promoters of the corporation 50,000 shares of common stock for their services in organizing the company. The board of directors valued these services at $ 620,000.

Feb. 19 Exchanged 100,000 shares of common stock for the following assets at the indicated fair market values:

Equipment $ 180,000
Building 440,000
Land 600,000
  1. Prepare general journal entries to record the transactions.
  2. Prepare the balance sheet of the company as of 2009 March 1.

Alternate problem C On 2009 July 3, Barr Company was authorized to issue 15,000 shares of common stock; 3,000 shares were issued immediately to the incorporators of the company for cash at $ 320 per share. On July 5 of that year, an additional 300 shares were issued to the incorporators for services rendered in organizing the company. The board valued these services at $ 96,000. On 2009 July 6, legal and printing costs of $ 12,000 were paid. These costs related to securing the corporate charter and the stock certificates.

  1. Set up T-accounts and post these transactions. Then prepare the balance sheet of the Barr Company as of the close of 2009 July 10, assuming the authorized stock has a $ 160 par value.
  2. Repeat (a) for the T-accounts involving stockholders’ equity, assuming the stock is no-par stock with a $ 240 stated value. Prepare the stockholders’ equity section of the balance sheet.
  3. Repeat (a) for the T-accounts involving stockholders’ equity, assuming the stock is no-par stock with no stated value. Prepare the stockholders’ equity section of the balance sheet.

Alternate problem D Tempo Company received its charter on 2009 April 1, authorizing it to issue: (1) 10,000 shares of $ 400 par value, $ 32 cumulative, convertible preferred stock; (2) 10,000 shares of $ 12 cumulative no-par preferred stock having a stated value of $ 20 per share and a liquidation value of $ 100 per share; and (3) 100,000 shares of no-par common stock without a stated value.

On April 2, incorporators of the corporation acquired 50,000 shares of the common stock for cash at $ 80 per share, and 200 shares were issued to an attorney for services rendered in organizing the corporation. On April 3, the company issued all of its authorized shares of $ 32 convertible preferred stock for land valued at $ 1,600,000 and a building valued at $ 4,800,000. The property was subject to a mortgage of $ 2,400,000. On April 8, the company issued 5,000 shares of the $ 12 preferred stock in exchange for a patent valued at $ 1,040,000. On April 10, the company issued 1,000 shares of common stock for cash at $ 80 per share.

  1. Prepare general journal entries for these transactions.
  2. Prepare the stockholders’ equity section of the 2009 April 30, balance sheet. Assume retained earnings were $ 80,000.
  3. Assume that each share of the $ 32 convertible preferred stock is convertible into six shares of common stock and that one-half of the preferred is converted on 2009 September 1. Give the required journal entry.

Alternate problem E Kane Company issued all of its 5,000 shares of authorized preferred stock on 2008 January 1, at $ 100 per share. The preferred stock is no-par stock, has a stated value of $ 5 per share, is entitled to a cumulative basic preference dividend of $ 6 per share, is callable at $ 110 beginning in 2009, and is entitled to $ 100 per share in liquidation plus cumulative dividends. On this same date, Kane also issued 10,000 authorized shares of no-par common stock with a $ 10 stated value at $ 50 per share.

On 2009 December 31, the end of its second year of operations, the company’s retained earnings amounted to $ 160,000. No dividends have been declared or paid on either class of stock since the date of issue.

Prepare the stockholders’ equity section of Kane Company’s 2009 December 31, balance sheet.

 

Beyond the numbers—Critical thinking

Business decision case A Rudd Company and Clay Company have extremely stable net income amounts of $ 4,800,000 and $ 3,200,000, respectively. Both companies distribute all their net income as dividends each year. Rudd Company has 100,000 shares of $ 80 par value, 6 per cent preferred stock, and 500,000 shares of $ 8 par value common stock outstanding. Clay Company has 50,000 shares of $ 40 par value, 8 per cent preferred stock, and 400,000 shares of $ 8 par value common stock outstanding. Both preferred stocks are cumulative.

  1. Compute the annual dividend per share of preferred stock and per share of common stock for each company.
  2. Based solely on the preceding information, which common stock would you predict to have the higher market price per share? Why?
  3. Which company’s stock would you buy? Why?

Business decision case B Jesse Waltrip recently inherited $ 480,000 cash that he wishes to invest in the common stock of either the West Corporation or the East Corporation. Both corporations have manufactured the same types of products for five years. The stockholders’ equity sections of the two corporations’ latest balance sheets follow:

 

WEST CORPORATION    
Stockholders’ equity:    
Paid-in capital:    
Common stock—$125 par value, 30,000 shares    
authorized, issued and outstanding   $3,750,000
Retained earnings   3,450,000
Total stockholders’ equity   $7,200,000
EAST CORPORATION    
Stockholders’ equity:    
Paid-in capital:    
Preferred stock—8%, $500 par value, cumulative 4,000 shares    
authorized, issued and outstanding $2,000,000  
Common stock—$125 par value, 40,000 shares authorized,    
issued and outstanding 5,000,000 $7,000,000
Retained earnings   560,000
Total stockholders’ equity   $7,560,000

The West Corporation has paid a cash dividend of $ 6 per share each year since its creation; its common stock is currently selling for $ 590 per share. The East Corporation’s common stock is currently selling for $ 480 per share. The current year’s dividend and three prior years’ dividends on the preferred stock are in arrears. The preferred stock has a liquidation value of $ 600 per share.

  1. What is the book value per share of the West Corporation common stock and the East Corporation common stock? Is book value the major determinant of market value of the stock?
  2. Based solely on the previous information, which investment would you recommend to Waltrip? Why?

Annual report analysis C Determine the 2003 return on average common stockholders’ equity for The Limited in the Annual report appendix. Explain in writing why this information is important to managers, investors, and creditors.

Ethics case D Refer to the ethics case concerning Joe Morrison to answer the following questions:

  1. Which alternative would benefit the company and its management over the next several years?
  2. Which alternative would benefit society?
  3. If you were Morrison, which side of the argument would you take?

Group project E In teams of two or three students, examine the annual reports of three companies and calculate each company’s return on common shareholders’ equity for the most recent two years. At least two years are needed to observe any changes. As a team, decide in which of the three companies you would invest. Appoint a spokesperson for the team to explain to the class which company the team would invest in and why.

Group project F In a team of two or three students, locate the annual reports of three companies that have preferred stock in their stockholders’ equity section. Determine the features of the preferred stock. Analyze the data in the annual report to determine whether dividends have been paid on the preferred stock each year. Are there dividends in arrears? Write a report to your instructor summarizing your findings. Also be prepared to make a short presentation to the class.

Group project G In a group of one or two students, contact state officials and/or consult library resources to inquire about the incorporation laws in your state. Determine your state laws regarding the issuance of stock at an amount below par value, how legal capital is determined, and the requirements and government fees for incorporating a company in your state. Write a report to your instructor summarizing the results of your investigation and be prepared to make a short presentation to your class.

Using the Internet—A view of the real world

Visit the following website for Macromedia:

http://www.macromedia.com

Pursue choices on the screen until you locate the consolidated statement of stockholders’ equity. You will probably go down some “false paths” to get to this financial statement, but you can get there. This experience is all part of learning to use the Internet. Note the changes that have occurred in the Common Stock, Additional Paid-In Capital, and Retained Earnings accounts. Check out the notes to the financial statements for further information. Write a memo to your instructor summarizing your findings.

Visit the following website for Gartner Group:

http://www.gartner.com

Pursue choices on the screen until you locate the consolidated statement of stockholders’ equity. You will probably go down some “false paths” to get to this financial statement, but you can get there. This experience is all part of learning to use the Internet. Trace the changes that have occurred in the last three years in the Common Stock account. Check out the notes to the financial statements for further information. Write a memo to your instructor summarizing your findings.

  1. [1]Some corporations have eliminated the preemptive right because the preemptive right makes it difficult to issue large blocks of stock to the stockholders of another corporation to acquire that corporation.