Problem 8 - Accounting

Question

Heritage Products Inc., a wholesaler of office products, was organized on February 19 of the current year, with an authorization of 60,000 shares of \(3 \%\) preferred stock, \(\$ 40\) par and 300,000 shares of \(\$ 75\) par common stock. The following selected transactions were completed during the first year of operations: Feb. 19. Issued 20,000 shares of common stock at par for cash. 27\. Issued 100 shares of common stock at par to an attorney in payment of legal fees for organizing the corporation. Mar. 13. Issued 6,000 shares of common stock in exchange for land, buildings, and equipment with fair market prices of \(\$ 80,000, \$ 350,000\), and \(\$ 45,000\), respectively. May 6. Issued 5,000 shares of preferred stock at \(\$ 46\) for cash. Journalize the transactions.

Step-by-Step Solution

Answer

Transactions involve debiting cash or expenses and crediting stock accounts, often with added capital for excess par.

Step 1: Understand the Transactions

We have a series of transactions that involve issuing shares of common and preferred stock. Our task is to journalize these transactions, identifying the involved accounts and the amounts for each.

Step 2: Journalize the February 19 Transaction

For February 19, Heritage Products Inc. issued 20,000 shares of common stock at par value \($75\) for cash. The journal entry is recorded as follows:- Debit: Cash for \(20,000 \times 75 = 1,500,000\)- Credit: Common Stock for the same amount of \(1,500,000\)

Step 3: Journalize the February 27 Transaction

On February 27, 100 shares of common stock were issued at par to pay for legal fees. The journal entry is recorded as:- Debit: Legal Fees Expense for \(100 \times 75 = 7,500\)- Credit: Common Stock for the same amount \(7,500\)

Step 4: Journalize the March 13 Transaction

On March 13, 6,000 shares of common stock were issued in exchange for land, buildings, and equipment. The entry involves adding the values of the assets:- Debit: Land for \(80,000\), Buildings for \(350,000\), Equipment for \(45,000\)- Credit: Common Stock for \(6,000 \times 75 = 450,000\)- Additional amounts should be allocated to Paid-In Capital in Excess of Par account for \(25,000\) since the total asset value \(475,000\) exceeds common stock value \(450,000\)

Step 5: Journalize the May 6 Transaction

On May 6, 5,000 shares of preferred stock are issued at \($46\) each. The journal entry is recorded as:- Debit: Cash for \(5,000 \times 46 = 230,000\)- Credit: Preferred Stock for \(5,000 \times 40 = 200,000\) and Paid-In Capital in Excess of Par – Preferred for \(5,000 \times 6 = 30,000\)

Key Concepts

Common Stock

Common stock represents a type of ownership in a corporation and gives shareholders voting rights. It is typically issued to raise capital for business operations.

• **Par Value:** In the Heritage Products Inc. exercise, the common stock had a par value of $75. Par value is the nominal or face value of a stock set by the company, but it often doesn't reflect the actual market value. It serves as a baseline for recording stock on the company’s balance sheet.
• **Issuing Common Stock:** In February, Heritage Products issued common stock on two occasions. On February 19, 20,000 shares were issued for cash, resulting in an inflow of $1,500,000. It's recorded as a debit to the Cash account and a credit to the Common Stock account, signifying an increase in equity.
• **Exchange for Services:** On February 27, the company issued 100 shares to an attorney for legal services during incorporation. This transaction required valuing the 100 shares at $7,500 (as their par value multiplied by the number of shares), equating to an expense recorded in Legal Fees Expense, balanced by the stock's recorded value.
• **Asset Exchange:** On March 13, common stock was part of an asset exchange. Issuing 6,000 shares against physical assets had a total market value of $475,000, though the common stock covered only $450,000. The extra $25,000 was recorded in Paid-In Capital in Excess of Par, reflecting a premium on the stock issuance.

Preferred Stock

Preferred stock is another class of shares that typically provides certain ownership advantages over common stock, specifically in dividends and asset distribution priorities.

• **Fixed Dividends:** Preferred shares usually yield fixed dividends, as seen with Heritage Products’ 3% preferred stock at a $40 par value.
• **Issuance with Premium:** On May 6, Heritage Products issued 5,000 preferred shares at $46 each, above their $40 par value. Issuing shares above par value means that any amount received beyond the par value is considered a premium. Thus, while the Preferred Stock account receives a credit equivalent to the par value ($200,000), the excess ($30,000) is credited to the Paid-In Capital in Excess of Par – Preferred, acknowledging the premium paid by investors.
• **Advantages Over Common Stock:** Preferred shareholders receive dividends before common shareholders and have priority in asset claims if the company dissolves, protecting their investment to some extent during financial difficulties.

Paid-In Capital

Paid-in capital represents funds shareholders have injected into the company by purchasing stock directly from it, often at an amount exceeding the stock’s par value.

• **Understanding Paid-In Capital:** It is a part of the shareholders' equity and consists of both the par value of the stock and any additional amount over it (premium). It is different from retained earnings, which are profits reinvested in the business.
• **Role in Transactions:** Throughout the year, Heritage Products Inc. had several instances (e.g., March 13 and May 6) where stocks were issued above par. On March 13, issuing common stock for assets reveals $25,000 added to Paid-In Capital in Excess of Par account. Similarly, the May 6 issuance of preferred stock includes $30,000 credited to Paid-In Capital in Excess of Par – Preferred, indicating transactions at a price above the established par value.
• **Importance for Investors:** This excess paid-in capital signifies investor confidence, as it shows investments at values higher than the designated par, reflecting positively on the company's financial reputation and growth potential.