Problem 3 - Accounting

Question

On February 10, Peerless Rocks Inc., a marble contractor, issued for cash 40,000 shares of \(\$ 10\) par common stock at \(\$ 34\), and on May 9 , it issued for cash 100,000 shares of \(\$ 5\) par preferred stock at \(\$ 7\). a. Journalize the entries for February 10 and May \(9 .\) b. What is the total amount invested (total paid-in capital) by all stockholders as of May 9?

Step-by-Step Solution

Answer

Total paid-in capital by May 9 is $2,060,000.

Step 1: Understanding the Problem

We need to record the journal entries for the issuance of common and preferred stocks on February 10 and May 9, respectively, and calculate the total amount of paid-in capital by May 9.

Step 2: Journal Entry for February 10

On February 10, Peerless Rocks Inc. issued 40,000 shares of common stock with a par value of \(10, selling them at \)34 per share. The entry is as follows:- **Debit** Cash account: \(40,000 \times 34 = 1,360,000\)- **Credit** Common Stock account for the par value: \(40,000 \times 10 = 400,000\)- **Credit** Additional Paid-In Capital - Common Stock for the excess: \(1,360,000 - 400,000 = 960,000\)

Step 3: Journal Entry for May 9

On May 9, the company issued 100,000 preferred shares at \(7 with a par value of \)5 per share. The entry is:- **Debit** Cash account: \(100,000 \times 7 = 700,000\)- **Credit** Preferred Stock account for the par value: \(100,000 \times 5 = 500,000\)- **Credit** Additional Paid-In Capital - Preferred Stock for the excess: \(700,000 - 500,000 = 200,000\)

Step 4: Calculating the Total Paid-In Capital by May 9

To find the total paid-in capital, we sum the cash received from both transactions:- Total from Common Stock: \(1,360,000\)- Total from Preferred Stock: \(700,000\)This results in Total Paid-In Capital: \(1,360,000 + 700,000 = 2,060,000\)

Key Concepts

Common Stock Issuance

When a company issues common stock, it is essentially raising funds by offering ownership shares to investors. Let's break down the process to understand it more clearly. For example, Peerless Rocks Inc. issued 40,000 shares at a par value of \(10 each. However, they sold these shares for more, at \)34 each. The steps to record this transaction include:

• Debit the Cash account to recognize the cash inflow from the sale. In this case, the total cash received is calculated by multiplying the number of shares by the selling price, which is \(40,000 \times 34\ = 1,360,000\) dollars.
• Credit the Common Stock account for the par value, which is \(40,000 \times 10\ = 400,000\) dollars. This represents the value of the stock issued based on its par value.
• Credit Additional Paid-In Capital for the excess amount over the par value. This is calculated as \(1,360,000 - 400,000\ = 960,000\) dollars.

The additional amount credited to the Additional Paid-In Capital account reflects the premium received over the stock's par value, indicating strong investor demand.

Preferred Stock Issuance

Preferred stock issuance operates under similar principles to common stock, but there are key distinctions. Preferred shares often come with stipulated dividends and specific priorities over common stockholders in case of liquidation.In May, Peerless Rocks Inc. issued 100,000 preferred shares with a par value of \(5 each, selling them at \)7 each. Here's how you journalize this:

• Debit the Cash account to acknowledge the cash inflow, which is \(100,000 \times 7\ = 700,000\) dollars.
• Credit the Preferred Stock account for the total par value, which is \(100,000 \times 5\ = 500,000\) dollars.
• Credit Additional Paid-In Capital for Preferred Stock for the excess, \(700,000 - 500,000\ = 200,000\) dollars.

The process ensures that the company's financial statements reflect both the cash flow and the changes in equity structure. Preferred stock, especially when issued at a premium, demonstrates investors' confidence in the company's long-term stability and potential for consistent dividends.

Paid-In Capital Calculation

Paid-in capital, also known as contributed capital, is the total capital a company receives from investors purchasing its stock. It's an essential metric since it reflects the financial investment made by stockholders in exchange for ownership.Calculating the total paid-in capital involves adding up all the cash resources received from stock issuances. For Peerless Rocks Inc.:

• The total cash from the issuance of common stock was \(1,360,000\) dollars.
• The total cash from the issuance of preferred stock was \(700,000\) dollars.

Summing these amounts gives the total paid-in capital as \(1,360,000 + 700,000 = 2,060,000\) dollars.This figure tells us how much money investors have put into Peerless Rocks Inc. in exchange for their ownership stakes. Paid-in capital is part of the shareholders' equity section in the balance sheet and provides insights into the company's capital structure and potential for growth.