Problem 16 - Accounting

Question

Sports Car Inc. retails racing products for BMWs, Porsches, and Ferraris. The following accounts and their balances appear in the ledger of Sports Car Inc. on November 30, the end of the current year: \(\begin{array}{lr}\text { Common Stock, } \$ 5 \text { par } & \$ 875,000 \\\ \text { Paid-In Capital in Excess of Par-Common Stock } & 700,000 \\ \text { Paid-In Capital in Excess of Par-Preferred Stock } & 25,000 \\ \text { Paid- In Capital from Sale of Treasury Stock-Common } & 16,000 \\ \text { Preferred } 3 \% \text { Stock, } \$ 75 \text { par } & 937,500 \\ \text { Retained Earnings } & 2,338,000 \\ \text { Treasury Stock-Common } & 165,000\end{array}\) Twenty thousand shares of preferred and 400,000 shares of common stock are authorized. There are 22,000 shares of common stock held as treasury stock. Prepare the Stockholders' Equity section of the balance sheet as of November 30 , the end of the current year.

Step-by-Step Solution

Answer

Total stockholders' equity is $4,726,500.

Step 1: Identify the Components of Stockholders' Equity

Stockholders' Equity includes several accounts: Common Stock, Preferred Stock, Paid-In Capital in Excess of Par (for both types of stock), Retained Earnings, and Treasury Stock. We need to organize these accounts appropriately in the Stockholders' Equity section.

Step 2: Calculate and Format Common Stock

The common stock has a par value of $5 and the value is given as $875,000. This provides us with the value of the common stock that is issued. We also know that out of the total issued shares, a portion might be held as treasury stock.

Step 3: Calculate and Format Preferred Stock

The preferred stock has a par value of \(75, with a balance of \)937,500. This implies issued shares are 12,500 (since \( 937,500 \div 75 = 12,500 \)).

Step 4: Calculate Paid-In Capital in Excess of Par-Common Stock

The paid-in capital in excess of par for common stock is given as $700,000. This reflects additional amounts paid by investors over the par value of common shares.

Step 5: Calculate Paid-In Capital in Excess of Par-Preferred Stock

The paid-in capital in excess of par for preferred stock is $25,000, as reflected in the data, meaning investors paid $25,000 more than the par value for the issued preferred shares.

Step 6: Consider Paid-In Capital from Sale of Treasury Stock

The company has a paid-in capital of $16,000 from the sale of treasury stock-common. This is treated as additional equity.

Step 7: Account for Treasury Stock

Treasury stock-common has a debit balance of $165,000. This represents repurchased shares and is deducted from total stockholders' equity.

Step 8: Add Retained Earnings

Retained earnings of $2,338,000 are added to the stockholders' equity section, representing accumulated profits not distributed as dividends.

Step 9: Assemble Stockholders' Equity Section

Combine the previous calculations as follows: 1. **Preferred Stock**: 937,500 2. **Common Stock**: 875,000 3. **Paid-In Capital in Excess of Par (Common)**: 700,000 4. **Paid-In Capital in Excess of Par (Preferred)**: 25,000 5. **Additional Paid-In Capital (Treasure Stock Sale)**: 16,000 6. **Retained Earnings**: 2,338,000 7. **Less: Treasury Stock**: (165,000) Calculate total stockholders' equity by summing these amounts.

Key Concepts

Common Stock

Common stock is a key component of a corporation's stockholders' equity. It represents ownership in a company and entitles shareholders to vote on corporate matters. In the case of Sports Car Inc., the common stock has a par value of $5, meaning each share is valued at this price in the equity account. The total value of common stock listed was $875,000, indicating how much was raised at par value through the issuance of these shares.
Common stock can also be subject to treasury stock transactions, where the company may buy back its own shares. These shares are initially part of the issued common stock but are held by the company itself rather than in the public or private domains.

Preferred Stock

Preferred stock differs from common stock in that it often does not provide voting rights but comes with a fixed dividend, which is paid before any dividends are issued to common stockholders. Sports Car Inc. has preferred stock with a par value of $75. There was a total balance of $937,500 from preferred stock at year-end, indicating the issuance of 12,500 shares (since $937,500 divided by $75 gives 12,500 shares).
Preferred stock is a vital financial tool for companies as it allows raising capital while maintaining less diluted voting control, as preferred shareholders typically do not have the same voting rights as common shareholders. It usually provides greater financial stability compared to common stock, given its fixed income nature.

Retained Earnings

Retained earnings represent the cumulative amount of a company's profit that has not been distributed to shareholders as dividends but instead reinvested in the business. Sports Car Inc. had retained earnings of $2,338,000 at the end of the year, which signifies the company has a substantial amount of profits reserved for future investments or to cover any potential financial downsides.
Retention of earnings facilitates growth as it provides the company with a self-generated source of finance. It's critical to find a balance, though, as shareholders often expect dividends as a return on their investment, and excessive retention may not be looked at favorably.

Treasury Stock

Treasury stock refers to shares that were once part of the outstanding shares of stock but were later repurchased by the company. This stock is then held by the corporation and may be reissued or retired completely. In the case of Sports Car Inc., the treasury stock is recorded with a debit balance of $165,000.
Owning treasury stock reduces the number of shares available on the open market, which can help to increase the value of remaining shares due to the reduction in supply while maintaining demand. However, it results in a reduction of stockholders' equity by the cost of the repurchased shares.