Problem 10 - Accounting

Question

Geyser Inc. develops and produces spraying equipment for lawn maintenance and industrial uses. On March 3 of the current year, Geyser Inc. reacquired 7,500 shares of its common stock at \(\$ 120\) per share. On August \(11,4,000\) of the reacquired shares were sold at \(\$ 130\) per share, and on October \(3,2,500\) of the reacquired shares were sold at \(\$ 124\). a. Journalize the transactions of March 3, August 11, and October 3 . b. What is the balance in Paid-In Capital from Sale of Treasury Stock on December 31 of the current year? c. What is the balance in Treasury Stock on December 31 of the current year? d. How will the balance in Treasury Stock be reported on the balance sheet?

Step-by-Step Solution

Answer

a. Journal entries include Treasury Stock and Cash transactions. b. Paid-In Capital balance is $50,000. c. Treasury Stock balance is $120,000. d. Treasury Stock is reported as a contra equity account with a $120,000 balance.

Step 1: Calculate Total Purchase Cost on March 3

Geyser Inc. reacquired 7,500 shares at a price of \(120 per share. To find the total cost of these treasury shares, multiply the number of shares by the purchase price per share:\[ \text{Total Cost} = 7,500 \times 120 = 900,000 \] The journal entry on March 3 will be to debit Treasury Stock and credit Cash for \)900,000.

Step 2: Record Sale on August 11

On August 11, 4,000 of the reacquired shares were sold at \(130 per share. Calculate the total cash received from the sale:\[ \text{Total Cash} = 4,000 \times 130 = 520,000 \]Next, find the cost of the shares sold, using the original purchase price:\[ \text{Cost of Sold Shares} = 4,000 \times 120 = 480,000 \]The difference between the sale price and the cost is credited to Paid-In Capital from Sale of Treasury Stock:\[ \text{Paid-In Capital} = 520,000 - 480,000 = 40,000 \]The journal entry will be:- Debit Cash: \)520,000- Credit Treasury Stock: \(480,000- Credit Paid-In Capital from Sale of Treasury Stock: \)40,000.

Step 3: Record Sale on October 3

On October 3, 2,500 shares were sold at \(124 per share. Calculate the total cash received from the sale:\[ \text{Total Cash} = 2,500 \times 124 = 310,000 \]Calculate the cost of these shares, using the original purchase price:\[ \text{Cost of Sold Shares} = 2,500 \times 120 = 300,000 \]Since the sale price is greater than the cost, the excess is credited to Paid-In Capital from Sale of Treasury Stock:\[ \text{Paid-In Capital} = 310,000 - 300,000 = 10,000 \]The journal entry will be:- Debit Cash: \)310,000- Credit Treasury Stock: \(300,000- Credit Paid-In Capital from Sale of Treasury Stock: \)10,000.

Step 4: Calculate Paid-In Capital Balance on December 31

The Paid-In Capital from Sale of Treasury Stock is accumulated from both sales:\[ \text{Total Paid-In Capital} = 40,000 + 10,000 = 50,000 \]

Step 5: Calculate Treasury Stock Balance on December 31

Initially, all 7,500 shares were reacquired. After the stock sales:- 4,000 shares were sold on August 11- 2,500 shares were sold on October 3The remaining shares in Treasury are:\[ \text{Remaining Treasury Shares} = 7,500 - (4,000 + 2,500) = 1,000 \]The balance in Treasury Stock is calculated using the original purchase price:\[ \text{Balance in Treasury Stock} = 1,000 \times 120 = 120,000 \]

Step 6: Report Treasury Stock on the Balance Sheet

Treasury Stock is reported as a contra equity account on the balance sheet, reducing total stockholders' equity. It will appear in the equity section with a balance of $120,000.

Key Concepts

Journal Entries

Journal entries are essential records in accounting used to record business transactions. They provide a systematic way to document daily financial activities and ensure accuracy in financial reporting.
In this exercise, Geyser Inc. had a series of transactions involving reacquiring and selling its own shares. Let's break down these events as journal entries:

• **March 3:** Geyser Inc. reacquired 7,500 shares of its stock at $120 each. The journal entry here would involve increasing the Treasury Stock account by debiting it for the total cost of $900,000. Cash, being the method of payment, will be credited with the same amount.
• **August 11:** The company sold 4,000 of the previously reacquired shares at $130 each. To record this, you debit Cash for the total income of $520,000. Then, you credit the Treasury Stock account with the initial cost of the shares, which is $480,000. The remaining amount ($40,000) appears as a credit to Paid-In Capital from Sale of Treasury Stock, as it represents the gain over the repurchase cost.


• **October 3:** On this date, 2,500 shares were sold at $124 each. The journal entry mirrors the previous transaction. Debit Cash for $310,000, credit Treasury Stock for $300,000 (the cost basis), and credit Paid-In Capital from Sale of Treasury Stock for $10,000.

These entries are crucial for ensuring the financial statements reflect accurate and transparent information regarding the company's ownership structure and financial performance.

Treasury Stock

Treasury stock represents shares that a company has reacquired after being previously issued to shareholders. These shares are not considered outstanding and do not carry voting rights or pay dividends, which offers companies significant control over their equity.
In the context of Geyser Inc., treasury stock transactions are reflected in steps regarding both the repurchase and sale of shares. Initially, 7,500 shares were reacquired and are recorded as treasury stock, reducing stockholders' equity.

The core aspects of how treasury stock works are:

• **Reacquisition:** When Geyser Inc. purchases its own stock, it is recorded as a treasury stock entry. It reduces the available cash and impacts overall equity by the cost of the shares purchased.


• **Resale:** Selling these shares, as evidenced on August 11 and October 3, allows the company to increase cash and potentially exceed the reacquisition cost. If sold for more than the repurchase cost, it creates additional paid-in capital.


• **Balance Reporting:** On the balance sheet, treasury stock is shown as a contra-equity account, indicating it reduces the total stockholders' equity. After the sales in our exercise, the remaining treasury stock has a net value of $120,000.

Understanding these dynamics helps in analyzing a company's financial strategy and assessing its liquidity management.

Paid-In Capital

Paid-in capital is a term denoting the funds received from investors in exchange for stock. Whenever a company's reacquired shares are sold for more than the original purchase cost, the excess is credited here as additional paid-in capital from treasury stock sales.
For Geyser Inc., the transactions involved selling treasury stock twice within the year, increasing paid-in capital in each instance:

• **August 11 Sale:** The company gained $40,000 over the cost of the shares sold. This is added to the Paid-In Capital from Sale of Treasury Stock, reflecting the profit made from the sale.


• **October 3 Sale:** Here, another profit of $10,000 was realized, which also contributed to the paid-in capital.
• **Total for the Year:** Together, these gains from the sale of treasury stock contribute $50,000 to the paid-in capital balance, enhancing shareholder equity without issuing new shares.

This concept is vital as it illustrates how companies can strategically handle treasury stock transactions to improve their equity position and leverage their finances without diluting shareholder value.