Problem 8 - Accounting

Question

Newgen Products Inc., a wholesaler of office products, was organized on February 20 of the current year, with an authorization of 75,000 shares of \(2 \%\) preferred stock, \(\$ 50\) par and 400,000 shares of \(\$ 15\) par common stock. The following selected transactions were completed during the first year of operations: Feb. 20. Issued 150,000 shares of common stock at par for cash. 26\. Issued 500 shares of common stock at par to an attorney in payment of legal fees for organizing the corporation. Mar. 6. Issued 18,000 shares of common stock in exchange for land, buildings, and equipment with fair market prices of \(\$ 50,000, \$ 275,000\), and \(\$ 60,000\), respectively. Apr. 30. Issued 20,000 shares of preferred stock at \(\$ 60\) for cash. Journalize the transactions.

Step-by-Step Solution

Answer

Four transactions are recorded: issuance of common stock for cash, for legal fees, for assets, and issuance of preferred stock, each with journal entries reflecting such activities.

Step 1: Journalize the Issuance of Common Stock on February 20

On February 20, Newgen Products Inc. issued 150,000 shares of common stock at par value of \(15 per share for cash. The journal entry will be:\[ \begin{align*} \text{Cash} & \quad 2,250,000 \quad (Debit) \ \text{Common Stock} & \quad 2,250,000 \quad (Credit) \end{align*} \]**Explanation:** 150,000 shares \(\times\) \)15 per share = $2,250,000. This amount is debited to the Cash account and credited to the Common Stock account to reflect the issuance.

Step 2: Journalize the Compensation for Legal Fees on February 26

On February 26, 500 shares of common stock were issued at par value (\(15) to an attorney as payment for legal fees incurred in organizing the corporation.The journal entry will be:\[ \begin{align*} \text{Legal Fees Expense} & \quad 7,500 \quad (Debit) \ \text{Common Stock} & \quad 7,500 \quad (Credit) \end{align*} \]**Explanation:** 500 shares \(\times\) \)15 per share = $7,500. This amount is debited to Legal Fees Expense, reflecting the expense of legal services, and credited to Common Stock.

Step 3: Journalize the Exchange for Land, Buildings, and Equipment on March 6

On March 6, 18,000 shares of common stock were issued in exchange for land, buildings, and equipment valued at \(50,000, \)275,000, and \(60,000, respectively. The journal entry will be:\[ \begin{align*} \text{Land} & \quad 50,000 \quad (Debit) \ \text{Buildings} & \quad 275,000 \quad (Debit) \ \text{Equipment} & \quad 60,000 \quad (Debit) \ \text{Common Stock} & \quad 270,000 \quad (Credit) \ \text{Paid-in Capital in Excess of Par} & \quad 115,000 \quad (Credit) \end{align*} \]**Explanation:**- Total value of assets received = \)385,000- Par value of stock issued = 18,000 shares \(\times\) \(15 per share = \)270,000 - Paid-in Capital in Excess of Par is credited for the amount, \(385,000 (total value of assets) - \)270,000 (par value of stock) = $115,000.

Step 4: Journalize the Issuance of Preferred Stock on April 30

On April 30, Newgen Products Inc. issued 20,000 shares of preferred stock at \(60 per share for cash. The journal entry will be:\[ \begin{align*} \text{Cash} & \quad 1,200,000 \quad (Debit) \ \text{Preferred Stock} & \quad 1,000,000 \quad (Credit) \ \text{Paid-in Capital in Excess of Par - Preferred Stock} & \quad 200,000 \quad (Credit) \end{align*} \]**Explanation:**- Cash received = 20,000 shares \(\times\) \)60 = \(1,200,000- Par value = 20,000 shares \(\times\) \)50 = \(1,000,000- The remainder above par value, \)200,000, is credited to Paid-in Capital in Excess of Par - Preferred Stock.

Key Concepts

Common Stock

Common stock represents the ownership in a company and signifies a claim on part of the company's assets and earnings. It is usually the most common type of stock that companies issue. Common stockholders have certain rights, such as the ability to vote on company matters like electing the board of directors.
When a company such as Newgen Products Inc. issues common stock, they receive cash or other assets. The par value in this exercise is set at $15 per share, which represents the minimum price at which stock can be issued. Common stock is recorded in the accounting system through journal entries. For example, when Newgen issued 150,000 shares at par for cash, the entry reflected the increase in cash and the issuance of common stock:

• Cash (Debit): $2,250,000
• Common Stock (Credit): $2,250,000

This entry highlights that the company received cash equal to the par value of the common stock issued.

Preferred Stock

Preferred stock is another form of equity and is distinct from common stock. It generally offers a fixed dividend and has a higher claim on assets than common stock, especially during liquidation. Unlike common stockholders, preferred stockholders usually do not have voting rights.
In the case of Newgen Products Inc., preferred stock was issued with a par value of $50, allowing for a steady dividend stream of 2% on the par value. When preferred stocks are issued, the entries reflect the cash inflow and the total value represented by the preferred shares. For example, Newgen's journal entry for issuing 20,000 shares at $60 each is as follows:

• Cash (Debit): $1,200,000
• Preferred Stock (Credit): $1,000,000
• Paid-in Capital in Excess of Par - Preferred Stock (Credit): $200,000

This illustrates how additional amounts received over the par value are recorded under the paid-in capital in excess of par.

Paid-in Capital

Paid-in capital is the amount of money that shareholders have invested in the company above the par value of its shares. This is an essential component of equity in the balance sheet and shows the additional capital paid by investors over and above the nominal value of the stock. Often, stocks are issued at a price higher than their par value, as seen in Newgen Products Inc.'s transactions. For instance, the company issued preferred stock at $60, which is $10 above the $50 par value.

In terms of accounting, the excess amount received over the par value is noted as paid-in capital in excess of par. Here's how it appears in journal entries:

• Paid-in Capital in Excess of Par - Common or Preferred Stock (Credit): Amount over the par value

This separate account ensures transparency by distinguishing the funds received above the nominal share value, indicating additional investor trust and extra capital infusion into the company.