Problem 15 - Accounting

Question

Health Co. is an HMO for twelve businesses in the Chicago area. The following account balances appear on the balance sheet of Health Co.: Common stock \((250,000\) shares authorized), \(\$ 100\) par, \(\$ 12,500,000\); Paid-in capital in excess of par-common stock, \(\$ 750,000\); and Retained earnings, \(\$ 30,578,000\). The board of directors declared a \(2 \%\) stock dividend when the market price of the stock was \(\$ 110\) a share. Health Co. reported no income or loss for the current year. a. Journalize the entries to record (1) the declaration of the dividend, capitalizing an amount equal to market value, and (2) the issuance of the stock certificates. b. Determine the following amounts before the stock dividend was declared: (1) total paid-in capital, (2) total retained earnings, and (3) total stockholders' equity. c. Determine the following amounts after the stock dividend was declared and closing entries were recorded at the end of the year: (1) total paid-in capital, (2) total retained earnings, and (3) total stockholders' equity.

Step-by-Step Solution

Answer

Declare the dividend: debit Retained Earnings 550,000; credit Common Stock 500,000, and Paid-in Capital in Excess 50,000. Before the dividend: Paid-in Capital 13,250,000, Retained Earnings 30,578,000, Total Equity 43,828,000. After dividend: Paid-in Capital 13,800,000, Retained Earnings 30,028,000, Total Equity 43,828,000.

Step 1: Calculate the Stock Dividend

To find out how many shares are included in the 2% stock dividend, multiply the number of shares outstanding by 2%: \[ \text{Stock Dividend Shares} = 250,000 \times 0.02 = 5,000 \text{ shares} \] The market value of these shares is: \[ \text{Market Value} = 5,000 \times 110 = 550,000 \, \text{USD} \]

Step 2: Journal Entry for Declaration of Dividend

Record the declaration of the stock dividend which increases Common Stock and Paid-in Capital by the par value and excess:- Debit Retained Earnings for the market value of stocks: \[ \text{Debit Retained Earnings} = 550,000 \]- Credit Common Stock for the par value of new shares: \[ \text{Credit Common Stock} = 5,000 \times 100 = 500,000 \]- Credit Paid-in Capital in Excess of Par for the remainder: \[ \text{Credit PIC in Excess of Par} = 550,000 - 500,000 = 50,000 \] So, the journal entry is:- Debit Retained Earnings: 550,000 - Credit Common Stock: 500,000- Credit Paid-in Capital in Excess of Par: 50,000

Step 3: Journal Entry for Issuance of Stock Certificates

Upon issuance of the stock certificates, no further entries beyond those already recorded for the stock dividend declaration are needed, as the new stock has been accounted for.

Step 4: Calculate Equity Before Dividend Declaration

Before the dividend, calculate total equity:1. Total Paid-in Capital includes: - Common Stock: 12,500,000 - Paid-in Capital in Excess of Par: 750,000 \[ \text{Total Paid-in Capital} = 12,500,000 + 750,000 = 13,250,000 \]2. Retained Earnings: 30,578,000 3. Total Stockholders' Equity is the sum of paid-in capital and retained earnings: \[ \text{Total Equity} = 13,250,000 + 30,578,000 = 43,828,000 \]

Step 5: Calculate Equity After Dividend Declaration

After the dividend, adjust total equity:1. Total Paid-in Capital now includes the new Common Stock and additional Paid-in Capital: - Common Stock: 12,500,000 + 500,000 = 13,000,000 - Paid-in Capital in Excess of Par: 750,000 + 50,000 = 800,000 \[ \text{Total Paid-in Capital} = 13,000,000 + 800,000 = 13,800,000 \]2. Retained Earnings decreases due to the dividend: \[ 30,578,000 - 550,000 = 30,028,000 \]3. Total Stockholders' Equity, however, remains unchanged, because the net result of a stock dividend doesn't change total equity: \[ \text{Total Equity} = 13,800,000 + 30,028,000 = 43,828,000 \]

Key Concepts

Retained Earnings

Retained earnings refer to the portion of net income that a company retains rather than distributing it as dividends to shareholders. In Health Co.'s case, after declaring a stock dividend, retained earnings decrease because the company uses part of these earnings to distribute stock to shareholders.
To calculate the impact of a stock dividend on retained earnings, you subtract the market value of the distributed stocks from the initial retained earnings.

• For instance, Health Co. had initial retained earnings of $ 30,578,000$.
• The stock dividend had a market value of $550,000$.
• Thus, updated retained earnings are $30,578,000 - $550,000 = $30,028,000$.

This shows how retained earnings are affected by a stock dividend declaration while keeping in mind that total stockholders' equity remains unchanged.

Paid-in Capital

Paid-in capital is the amount of money a company raises from investors in exchange for stock, representing investment directly into the company. After a stock dividend, paid-in capital increases as the company issues new shares to existing shareholders.
In Health Co.'s scenario, after declaring a 2% stock dividend:

• Common stock at par increases. The original common stock value was $12,500,000, and the value of new shares at par was $500,000, increasing common stock to $13,000,000.
• Paid-in Capital in Excess of Par also increases. The original was $750,000, climbing by $50,000 from the stock dividend to reach $800,000.

Thus, total paid-in capital increases with the issuance of new stock, summing to $13,800,000.

Financial Statements

Financial statements are essential tools in understanding the financial health of a company. They include the balance sheet, income statement, and cash flow statement, reflecting the economic performance and position of a business.
In relation to stock dividends, the balance sheet especially showcases changes. For Health Co., the stock dividend impacts the components of the equity section:

• Total equity before the dividend was $43,828,000, combining paid-in capital and retained earnings.
• After the dividend declaration, although there is a shift between retained earnings and paid-in capital, total equity remains unchanged at $43,828,000.

This stability in total equity despite a stock dividend exemplifies how financial statements display data shifts while maintaining overall equity balance.