Question

 

Jane Jones organized Kinney Enterprise, Inc., in January 2018. The corporation immediately issued at $15 per share on half of its 260,000 authorized shares of $1 par value common stock. On January 2, 2019, the corporation sold at par value the entire 10,000 authorized shares of 10 percent, $100 par value cumulative preferred stock. On January 2, 2020, the company again needed capital and issued 5,000 shares of an authorized 8,000 shares of no-par cumulative preferred stock for a total of $320,000. The no-par shares have a stated dividend of $6 per share.

The company declared no dividends in 2018 and 2019. At the end of 2019, its retained earnings were 530,000. During 2020 and 2021 combined, the company earned a total net income of $1,400,000. Dividends of 90 cents per share in 2020 and $2 per share in 2021 were paid on common stock.

Required:

1.   Prepare the stockholders’ equity section of the balance sheet at December 31, 2021. Include a supporting schedule showing your computation of retained earnings at the balance sheet date. Ensure that your partial balance sheet is labeled correctly and uses the correct format for the stockholders’ equity section of the balance sheet.

2. Assume that on January 2, 2019, the corporation could have borrowed $1,000,000 at 10 percent interest on a long-term basis instead of issuing the 10,000 shares of the $100 par value cumulative preferred stock. Identify two reasons a corporation may choose to issue cumulative preferred stock rather than finance operations with long-term debt.

Answer 1

Kinney Enterprise Inc
Partial Balance Sheet Dec 31,2021
Liabilities	Amount
Stock Holders Equity
10% cumulative preferred Stock
$ 100 par value 10,000 shares
authorised, issued and outstanding	10,00,000
$ 6 cumulative preferred stock
par value. 8000 shares authorised	320000
5000 issued and outstandind
Common Stock $ 1 par, 260000
shares authorised 130000 shares
issued and outstanding	130000
Additional Paid in capital:
Common Stock	1820000
Total paid in capital	32,70,000
Retained Earnings	1193000
Total Stock Holders Equity	44,63,000
Computation of Retained Earnings
Particulars	Amount
Retained Earnings at Dec 31,2019	530000
(+) Net Income for 2020-21	1400000
	1930000
(-) Dividends paid on 10% preferred stock
2019 (100000 in arrears)	-100000
2020 (100000 in arrears)	-100000
2021 (10% x $ 100 x 10000 shares)	-100000
(-) Dividends paid on $ 6 preferred stock
2020 (6 x 5000 shares)	-30000
2021 (6 x 5000 shares)	-30000
(-) Dividends paid on common stock
2020 (0.90 x 130000 shares)	-117000
2021 (2.00 x 130000 shares)	-260000
Retained Earnings at Dec 31,2021	1193000

2.

A corporation might decide to use cumulative preferred stock rather than debt to finance operations for any of the following reasons (only 2 required):

1. Although cumulative dividends must eventually be paid if the corporation is profitable, they do not have to be paid each year and do not become a legal obligation of the corporation until they are declared. Interest on debt is a legal obligation of the corporation and must be paid each year.

2. Debt must be repaid at some future date. To be a permanent source of capital, debt must be periodically refinanced. Preferred stock generally does not mature.

3. Increasing the amount of debt on a balance sheet can adversely affect financial ratios.