Question

AP11-6 (Equity transactions)

Southern Exposure Ltd. begins operations on January 2, 2016. During the year, the following transactions affect shareholders’ equity:

1. Southern Exposure’s articles of incorporation authorizes the issuance of 1 million common shares, and the issuance of 100,000 preferred shares, which pay an annual dividend of $2 per share.

2. A total of 240,000 common shares are issued for $5 a share.

3. A total of 15,000 preferred shares are issued for $14 per share. 4. The full annual dividend on the preferred shares is declared. 5. The dividend on the preferred shares is paid. 6. A dividend of $0.10 per share is declared on the common shares but is not yet paid. 7. The company has net income of $150,000 for the year. (Assume sales of $750,000 and total operating

expenses of $600,000.) 8. The dividends on the common shares are paid. 9. The closing entry for the dividends declared accounts is prepared.

Required:

a. Prepare journal entries to record the above transactions, including the closing entries for net income and dividends declared.

b. Prepare the shareholders’ equity section of the statement of financial position as at December 31, 2016. c. Why would an investor choose to purchase the common shares rather than the preferred shares? Or vice versa?

Answer 1

Answers

• All working forms part of the answer
• Journal Entries don’t require explanation, working is provided
• Requirement A

Transaction no.	Accounts title	Debit	Credit
1	NO Entry
2	Cash	$           1,200,000.00
	Common Stock		$    1,200,000.00
3	Cash	$             210,000.00
	Preferred Stock		$        210,000.00
4	Dividend	$                 30,000.00
	Dividend payable		$          30,000.00
5	Dividend payable	$                 30,000.00
	Cash		$          30,000.00
6	Dividend	$                 24,000.00
	Dividend payable		$          24,000.00
7	Income Summary	$              150,000.00
	Retained Earnings		$        150,000.00
8	Dividend payable	$                 24,000.00
	Cash		$          24,000.00
9	Retained Earnings	$                 54,000.00
	Dividends [30000 + 24000]		$          54,000.00

• Requirement B

Balance Sheet [Partial]
Stockholders' Equity
Common Stock [240,000 shares issued at $5]	$ 1,200,000.00
Preferred Stock [15,000 shares issued at $14]	$      210,000.00
Total Paid in Capital		$ 1,410,000.00
Retained Earnings [150,000 Net Income - 54,000 dividends]		$        96,000.00
Total Stockholder's Equity		$ 1,506,000.00

• An investor would prefer investing in purchasing Common Stock rather than preferred stock because:

---Common Stock have possibility of growth.

---Dividend rate is not fixed and in case of higher Net Income, higher dividend would be received.

• AN investor would prefer investing in purchasing Preferred stock rather than Common STokc because:

---Preferred Stock give a guarantee of fixed dividend income to be received.

---Preference is given in payment of dividend and repayment of capital.

---Investment is less risky than investment in common stock.