Problem 3 - Accounting

Question

On February 4, Cinderella Rocks Inc., a marble contractor, issued for cash 30,000 shares of \(\$ 20\) par common stock at \(\$ 64\), and on March 31 , it issued for cash 18,000 shares of \(\$ 75\) par preferred stock at \(\$ 90\). a. Journalize the entries for February 4 and March 31 . b. What is the total amount invested (total paid-in capital) by all stockholders as of March 31 ?

Step-by-Step Solution

Answer

Total paid-in capital as of March 31 is \( \$ 3,540,000 \).

Step 1: Identify Key Information for February 4

For February 4, Cinderella Rocks Inc. issued 30,000 shares of common stock with a par value of \( \\( 20 \) each for \( \\) 64 \) per share.

Step 2: Calculate Proceeds and Par Value for February 4

Compute the proceeds from the sale: \( 30,000 \text{ shares} \times \\( 64 = \\) 1,920,000 \). Calculate the par value: \( 30,000 \text{ shares} \times \\( 20 = \\) 600,000 \). The excess over par value is \( \\( 1,920,000 - \\) 600,000 = \$ 1,320,000 \).

Step 3: Journal Entry for February 4

Record the journal entry: - Debit Cash \( \\( 1,920,000 \) - Credit Common Stock \( \\) 600,000 \) - Credit Paid-in Capital in Excess of Par—Common \( \$ 1,320,000 \)

Step 4: Identify Key Information for March 31

On March 31, Cinderella Rocks Inc. issued 18,000 shares of preferred stock with a par value of \( \\( 75 \) each for \( \\) 90 \) per share.

Step 5: Calculate Proceeds and Par Value for March 31

Compute the proceeds from the sale: \( 18,000 \text{ shares} \times \\( 90 = \\) 1,620,000 \). Calculate the par value: \( 18,000 \text{ shares} \times \\( 75 = \\) 1,350,000 \). The excess over par value is \( \\( 1,620,000 - \\) 1,350,000 = \$ 270,000 \).

Step 6: Journal Entry for March 31

Record the journal entry: - Debit Cash \( \\( 1,620,000 \) - Credit Preferred Stock \( \\) 1,350,000 \) - Credit Paid-in Capital in Excess of Par—Preferred \( \$ 270,000 \)

Step 7: Total Paid-in Capital Calculation

Add up the paid-in capital amounts: - Common stock at par: \( \\( 600,000 \) - Paid-in capital in excess of par (common): \( \\) 1,320,000 \)- Preferred stock at par: \( \\( 1,350,000 \) - Paid-in capital in excess of par (preferred): \( \\) 270,000 \) Total paid-in capital is \( \$ 3,540,000 \).

Key Concepts

Common Stock

Common stock represents ownership in a company and a claim on a part of the company's profits and assets. When a company issues common stock, it allows investors to buy shares, providing capital to the business. Each share has a par value, which is a standard amount set for the stock, often much less than the market value.

In the case of Cinderella Rocks Inc., 30,000 common shares were issued at a par value of $20 per share, but were sold at $64 per share. This means investors paid a total of $1,920,000 for shares with a par value of $600,000. The extra $1,320,000 is known as paid-in capital in excess of par value. This amount shows the additional money investors are willing to pay above the minimum required par value, reflecting their belief in the company's potential for future growth.

Common stockholders usually have voting rights, typically one vote per share, which can be exercised in company decisions like electing directors. However, they have lower priority than preferred stockholders when it comes to receiving dividends. Despite potentially lower guaranteed returns, common stock can offer higher long-term growth potential.

Preferred Stock

Preferred stock is another form of corporate equity, but it differs from common stock in several ways. Primarily, preferred stockholders have priority over common stockholders concerning dividends and assets in the event of a liquidation. However, they typically do not have voting rights in corporate decisions.

On March 31, Cinderella Rocks Inc. issued 18,000 shares of preferred stock. These shares came with a par value of $75 but were sold for $90 each. The total sale brought in $1,620,000, with the par value calculated at $1,350,000. The over-par amount of $270,000 became the paid-in capital in excess of par for preferred stock.

Preferred stock can be thought of as a hybrid between equity and a fixed-income investment. It offers steady dividends (often higher than those of common stock) and provides a higher claim on assets compared to common stock, offering more security in volatile markets. Preferred stock is suitable for investors seeking fixed-cycle returns with some equity participation.

Paid-in Capital

Paid-in capital is a term used in accounting to represent the total amount of cash or other assets received from investors in exchange for stock. It's a crucial figure on a company's balance sheet, emphasizing the financial commitment from shareholders. Maximal clarity on paid-in capital can help in understanding a company’s financial health.

In the context of both common and preferred stock, the paid-in capital includes the par value of the shares as well as any excess over par value that investors have paid. For Cinderella Rocks Inc., the total paid-in capital calculated amounts to $3,540,000. This sum comprises:

• Common stock at par value: $600,000
• Paid-in capital in excess of par—Common: $1,320,000
• Preferred stock at par value: $1,350,000
• Paid-in capital in excess of par—Preferred: $270,000

Paid-in capital is an important indicator for the market—it shows the level of trust investors have in the company’s potential to generate returns. Companies can use this capital for expansion, paying off debt, or other strategic activities.