Corporations and equity: answer key
Answer key: the accepted entries with the amounts of the worksheet, and why.
Convention: United States (US textbooks)
Issuing common stock above par
A corporation issues 4000 shares of common stock with a par value of $5.00 per share at $12.50 per share. The buyers pay the full price in cash.
Assumptions: Issue costs are ignored.
Account Debit Credit Cash $50,000.00 Common Stock $20,000.00 Paid-in Capital in Excess of Par—Common Stock $30,000.00 Why
Cash received is 4000 × $12.50 = $50,000.00. Common Stock takes only the par value, 4000 × $5.00 = $20,000.00; the excess, $30,000.00, is Paid-in Capital in Excess of Par.
Declaring a cash dividend
The board of directors declares a cash dividend of $30,000.00, to be paid to the stockholders next month. Record the declaration.
Assumptions: Only the declaration is recorded here; the payment is a separate entry.
Account Debit Credit Dividends $30,000.00 Dividends Payable $30,000.00 Also accepted
Account Debit Credit Retained Earnings $30,000.00 Dividends Payable $30,000.00 Why
On the declaration date the corporation becomes liable for $30,000.00: credit Dividends Payable. The debit reduces equity: Dividends (closed to Retained Earnings at year end) or Retained Earnings directly; both are accepted. No cash moves until the payment date.
Paying a declared dividend
Last month the board of directors declared a cash dividend of $30,000.00. Today, the payment date, the corporation pays it in cash.
Assumptions: The dividend was recorded when it was declared.
Account Debit Credit Dividends Payable $30,000.00 Cash $30,000.00 Why
Paying the dividend settles the liability recorded on the declaration date: debit Dividends Payable and credit Cash for $30,000.00. Dividends and Retained Earnings are not touched again.
Buying treasury stock
A corporation buys back 400 shares of its own common stock (par value $5.00) at $18.00 per share in cash, to hold them as treasury stock.
Assumptions: Cost method: treasury stock is recorded at what it cost. Brokerage fees are ignored.
Account Debit Credit Treasury Stock $7,200.00 Cash $7,200.00 Why
Under the cost method, Treasury Stock (a contra-equity account) is debited with the full cost, 400 × $18.00 = $7,200.00, and Cash is credited. Par value and the original issue price play no part until the shares are reissued or retired.
Declaring and paying a dividend the same day
The board of directors of a small, closely held corporation declares a cash dividend of $15,000.00 and pays it in cash the same day.
Assumptions: One entry records the declaration and the payment.
Account Debit Credit Dividends $15,000.00 Cash $15,000.00 Also accepted
Account Debit Credit Retained Earnings $15,000.00 Cash $15,000.00 Why
Equity decreases by $15,000.00 through Dividends or directly through Retained Earnings (both are accepted), and Cash decreases by the same amount. Declared and paid at once, nothing is left in Dividends Payable; recording it there and settling it at once nets to zero and is also accepted.
Converting a loan into shares
A corporation owes $60,000.00 on a long-term note payable to a private investor. They agree that the corporation settles the whole note by issuing 4000 shares of common stock with a par value of $5.00 per share to the investor. Record the conversion.
Assumptions: No interest is owed, and the stock issued is worth exactly the carrying amount of the note, so there is no gain or loss on settling it. Costs are ignored.
Account Debit Credit Notes Payable $60,000.00 Common Stock $20,000.00 Paid-in Capital in Excess of Par—Common Stock $40,000.00 Why
The note payable of $60,000.00 is extinguished. Common Stock takes the par value, 4000 × $5.00 = $20,000.00; the rest, $60,000.00 − $20,000.00 = $40,000.00, is Paid-in Capital in Excess of Par. No cash changes hands.
Closing a corporation’s net income to Retained Earnings
On December 31, after the revenue and expense accounts have been closed, a corporation’s Income Summary has a credit balance of $74,500.00. Close Income Summary to Retained Earnings.
Assumptions: In a US corporation, net income is closed to Retained Earnings at year end; there is no separate appropriation entry after the shareholders’ meeting.
Account Debit Credit Income Summary $74,500.00 Retained Earnings $74,500.00 Why
Income Summary is debited for $74,500.00 to leave it at zero, and Retained Earnings is credited: the year’s net income stays in the corporation.
Closing a corporation’s net loss to Retained Earnings
On December 31, after the revenue and expense accounts have been closed, a corporation’s Income Summary has a debit balance of $23,600.00. Close Income Summary to Retained Earnings.
Assumptions: In a US corporation, a net loss is closed to Retained Earnings at year end; there is no separate entry after the shareholders’ meeting.
Account Debit Credit Retained Earnings $23,600.00 Income Summary $23,600.00 Why
Income Summary is credited for $23,600.00 to leave it at zero, and Retained Earnings is debited: the net loss reduces retained earnings.
Issuing common stock in exchange for land
A corporation issues 5000 shares of common stock with a par value of $10.00 per share to an investor in exchange for a plot of land. The land’s fair value is $90,000.00.
Assumptions: The land’s fair value is the best measure of what the stock is worth. Costs are ignored.
Account Debit Credit Land $90,000.00 Common Stock $50,000.00 Paid-in Capital in Excess of Par—Common Stock $40,000.00 Why
Land is recorded at its fair value, $90,000.00. Common Stock takes the par value, 5000 × $10.00 = $50,000.00; the excess, $40,000.00, is Paid-in Capital in Excess of Par.
Not in this convention: Allocating profit to the legal reserve
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