Problem 4 - Accounting

Question

On July 17, America Carpet Inc., a carpet wholesaler, issued for cash 150,000 shares of no-par common stock (with a stated value of \(\$ 5\) ) at \(\$ 36\), and on September 20, it issued for cash 10,000 shares of \(\$ 50\) par preferred stock at \(\$ 80\). a. Journalize the entries for July 17 and September 20, assuming that the common stock is to be credited with the stated value. b. What is the total amount invested (total paid-in capital) by all stockholders as of September 20?

Step-by-Step Solution

Answer

Total paid-in capital by September 20 is \( \$6,200,000 \).

Step 1: Understand the Transaction on July 17

On July 17, America Carpet Inc. issued 150,000 shares of no-par common stock with a stated value of \( \\(5 \) per share at \( \\)36 \) each. This means that the common stock has a stated value, but it is issued at a price higher than this value per share.

Step 2: Calculate Journal Entry for July 17

For each of the 150,000 shares, \( \\(5 \) will go to the Common Stock account, and the difference of \( \\)36 - \\(5 = \\)31 \) will represent the Additional Paid-In Capital for each share.Calculation details:- **Common Stock:** \( 150,000 \times \\(5 = \\)750,000 \)- **Additional Paid-In Capital:** \( 150,000 \times \\(31 = \\)4,650,000 \)**Journal Entry:**\[\begin{align*}\text{Cash} & \quad \text{Debit } \\(5,400,000 \\text{Common Stock} & \quad \text{Credit } \\)750,000 \\text{Additional Paid-In Capital (Common Stock)} & \quad \text{Credit } \$4,650,000 \\end{align*}\]

Step 3: Understand the Transaction on September 20

On September 20, the company issued 10,000 shares of \( \\(50 \) par preferred stock at \( \\)80 \) per share. Par value is the nominal value of the stock, but it is issued at a market price above this value per share.

Step 4: Calculate Journal Entry for September 20

For each of the 10,000 shares, \( \\(50 \) will be credited to the Preferred Stock account, and the difference \( \\)80 - \\(50 = \\)30 \) will go to the Additional Paid-In Capital for preferred stock.Calculation details:- **Preferred Stock:** \( 10,000 \times \\(50 = \\)500,000 \)- **Additional Paid-In Capital (Preferred Stock):** \( 10,000 \times \\(30 = \\)300,000 \)**Journal Entry:**\[\begin{align*}\text{Cash} & \quad \text{Debit } \\(800,000 \\text{Preferred Stock} & \quad \text{Credit } \\)500,000 \\text{Additional Paid-In Capital (Preferred Stock)} & \quad \text{Credit } \$300,000 \\end{align*}\]

Step 5: Calculate Total Paid-In Capital

The total paid-in capital by all stockholders by September 20 includes:- **Common Stock and its Additional Paid-In Capital**: \( \\(750,000 + \\)4,650,000 = \\(5,400,000 \)- **Preferred Stock and its Additional Paid-In Capital**: \( \\)500,000 + \\(300,000 = \\)800,000 \)**Total Paid-In Capital**: \( \\(5,400,000 + \\)800,000 = \$6,200,000 \)

Key Concepts

Common Stock

Common stock represents ownership in a company and carries voting rights that can influence corporate decisions. When a company like America Carpet Inc. issues common stock, they sell shares to investors. This raises capital for the business, while providing investors a piece of the company.
When America Carpet Inc. issued 150,000 shares of no-par common stock with a stated value of $5, but at a selling price of $36, they recorded the transaction in the following way:

• Stated Value of Common Stock: $5
• Selling Price of Common Stock: $36
• Number of Shares Issued: 150,000

To reflect this in the company's financial records, the common stock account received a credit for the stated value ($5 per share), totaling $750,000. The difference between the selling price and the stated value, which is $31 per share, was credited to Additional Paid-In Capital, summing up to $4,650,000. The total cash received from issuing common stock was $5,400,000. This method helps investors and the company track the contribution to equity that is above the stated value of the stock.

Preferred Stock

Preferred stock is a type of equity that can be considered a blend of a stock and a bond. Unlike common stock, it generally does not come with voting rights. However, it typically offers a fixed dividend, providing more predictable income for investors.
For the preferred stock issued by America Carpet Inc., the process was similar to common stock but with a different focus:

• Par Value of Preferred Stock: $50
• Selling Price of Preferred Stock: $80
• Number of Preferred Shares Issued: 10,000

The par value is recorded in the Preferred Stock account, totaling $500,000 for 10,000 shares. The difference of $30 per share between the selling price and par value is credited to Additional Paid-In Capital, adding another $300,000. The total cash received from issuing preferred stock was $800,000. Understanding these figures helps grasp how preferred stock enhances a company’s equity without exorbitant demands on cash flow, while potentially improving the attractiveness to risk-averse investors.

Paid-In Capital

Paid-in capital represents the total amount that shareholders have invested in the company in exchange for common or preferred stock. It is essential in assessing a company's financial stability and growth capacity.
In the case of America Carpet Inc., the calculated total paid-in capital accounts for money received from issuing both common and preferred stock. Here's how it breaks down:

• Common Stock and Additional Paid-In Capital: $750,000 + $4,650,000 = $5,400,000
• Preferred Stock and Additional Paid-In Capital: $500,000 + $300,000 = $800,000

The summation of these amounts results in a total paid-in capital of $6,200,000. This metric is crucial because it offers insight into the financial input from investors, beyond what is obligated by the nominal value of the stock. Paid-in capital allows companies to fund operations, invest in new projects, and maintain a stronger financial footing, which can, in turn, increase shareholder confidence and attract further investment.