Problem 8 - Accounting

Question

Calvert Products Inc., a wholesaler of office products, was organized on January 5 of the current year, with an authorization of 80,000 shares of \(2 \%\) noncumulative preferred stock, \(\$ 50\) par and 250,000 shares of \(\$ 100\) par common stock. The following selected transactions were completed during the first year of operations: Jan. 5. Issued 10,000 shares of common stock at par for cash. 18\. Issued 100 shares of common stock at par to an attorney in payment of legal fees for organizing the corporation. Feb. 13. Issued 4,250 shares of common stock in exchange for land, buildings, and equipment with fair market prices of \(\$ 50,000, \$ 280,000\), and \(\$ 120,000\), respectively. April 1. Issued 3,500 shares of preferred stock at \(\$ 52\) for cash. Journalize the transactions.

Step-by-Step Solution

Answer

Journal entries record cash received, services, and assets exchanged for stock.

Step 1: Issuance of Common Stock for Cash (January 5)

To journalize the issuance of 10,000 shares of common stock at par for cash, we record the following:- Debit Cash for the total amount received from issuing the shares. This is calculated as \(5,000\, ext{shares} \times \\(100 \) per share. - Credit Common Stock since the shares are issued at par.Journal entry:\[\begin{align*}\text{Date: } & \quad \text{Journal Entry} \\text{Jan 5} & \quad \text{Cash} \quad \text{Debit} \quad \\)1,000,000 \& \quad \text{Common Stock} \quad \text{Credit} \quad \$1,000,000\end{align*}\]

Step 2: Issuance of Common Stock for Legal Fees (January 18)

To record 100 shares of common stock issued at par for legal fees:- Debit Professional Fees Expense for the fair value of the services received.- Credit Common Stock as shares are issued at par value.Journal entry:\[\begin{align*}\text{Date: } & \quad \text{Journal Entry} \\text{Jan 18} & \quad \text{Professional Fees Expense} \quad \text{Debit} \quad \\(10,000 \& \quad \text{Common Stock} \quad \text{Credit} \quad \\)10,000\end{align*}\]

Step 3: Issuance of Common Stock for Assets (February 13)

For issuing 4,250 shares of common stock in exchange for land, buildings, and equipment, we will:- Debit Land, Buildings, and Equipment for their fair market values respectively.- Credit Common Stock for the par value of the shares issued.- Credit Additional Paid-In Capital for the difference.Journal entry:\[\begin{align*}\text{Date: } & \quad \text{Journal Entry} \\text{Feb 13} & \quad \text{Land} \quad \text{Debit} \quad \\(50,000 \& \quad \text{Buildings} \quad \text{Debit} \quad \\)280,000 \& \quad \text{Equipment} \quad \text{Debit} \quad \\(120,000 \& \quad \text{Common Stock} \quad \text{Credit} \quad \\)425,000 \& \quad \text{Additional Paid-In Capital} \quad \text{Credit} \quad \$25,000\end{align*}\]

Step 4: Issuance of Preferred Stock for Cash (April 1)

For issuing 3,500 shares of preferred stock at \(\\(52\):- Debit Cash for the total amount received (3,500 shares \(\times\) \\)52).- Credit Preferred Stock for the par value of the shares.- Credit Additional Paid-In Capital for the excess over par value.Journal entry:\[\begin{align*}\text{Date: } & \quad \text{Journal Entry} \\text{Apr 1} & \quad \text{Cash} \quad \text{Debit} \quad \\(182,000 \& \quad \text{Preferred Stock} \quad \text{Credit} \quad \\)175,000 \& \quad \text{Additional Paid-In Capital Preferred Stock} \quad \text{Credit} \quad \$7,000\end{align*}\]

Key Concepts

Common Stock Issuance

Common stock represents ownership in a corporation, and issuing common stock is a primary way for a company to raise capital. When a company like Calvert Products Inc. issues common stock, it becomes a shareholder-owned entity.

In the scenario provided, the company issued common stock at par value. The par value is the nominal or face value of a stock; it's typically set to avoid stocks being sold at less than a certain value.

• On January 5, Calvert issued 10,000 shares of common stock at $100 par value, receiving $1,000,000 in cash. Here, you'd record a debit to the "Cash" account, increasing assets, and a credit to "Common Stock", indicating increased equity.
• On January 18, 100 shares were issued for legal services rendered, valued at $10,000. This involves debiting "Professional Fees Expense" and crediting "Common Stock" to reflect the service payment made in shares.

Common stockholders often have certain rights like voting at shareholder meetings and receiving dividends when declared.

Preferred Stock

Preferred stock is a type of equity that generally offers no voting rights but gives investors a higher claim on assets and earnings than common stockholders.
Preferred stockholders typically have priority in receiving dividends and are paid before common stockholders in the event of a liquidation. This makes preferred stock a sought-after option for investors seeking steady income.

Calvert Products Inc. issued 3,500 shares of its preferred stock on April 1 at $52 per share. The par value of the preferred stock was $50, meaning the stock was issued at a premium.

• The journal entry for this transaction would include a debit to "Cash" for the total received, which is 3,500 shares multiplied by $52.
• "Preferred Stock" is credited for the par value per share times the number of shares. Any amount beyond the par value is recorded as "Additional Paid-In Capital" for preferred stock.

While preferred stockholders enjoy the benefit of dividends, such dividends are fixed and do not typically increase with company profits, unlike common stock.

Additional Paid-In Capital

Additional paid-in capital (APIC) refers to the difference between the par value and the amount paid by investors when purchasing stock. It's an entry that reflects the actual financial contribution of the shareholders beyond the nominal value of the stock.

In the example given, the issuance of preferred stock resulted in additional paid-in capital that represents the excess amount paid over its par value. This is recorded in financial statements under equity.

• During the transaction on April 1, when Calvert Products Inc. issued preferred stock, the total excess amount received (over the par value) was credited as APIC.
• Similarly, on February 13, the difference between the total fair market value of the land, buildings, and equipment and the par value of the common stock issued was recorded as "Additional Paid-In Capital". This entry is crucial for understanding how much investors have paid the company over and above the basic cost of their shares.

APIC is an important measure of how much new equity a company has raised and is a potent indicator of investor faith in its growth potential.

Financial Transactions

Journal entries are the backbone of recording financial transactions within a company. Properly documenting transactions ensures the accuracy and reliability of financial statements.

Calvert Products Inc.'s transactions involve journalizing entries for stock activities such as stock issuance, which helps in understanding equity dynamics within the company.

• These journal entries reflect all exchanges involving cash, services, or non-cash assets like land and buildings.
• Recording these transactions accurately ensures that financial health and company equity are clearly represented.
• Financial transactions not only display momentary health but also provide insight into long-term strategic outcomes based on investment and asset acquisition decisions.

Understanding journal entries aids in grasping how stock issuance impacts the company's financial position, enabling informed decision-making for management and investors alike.