Question

Maria Martinez organized Manhattan Transport Company in January 2015. The corporation

immediately issued at $8 per share one-half of its 200,000 authorized shares of $2 par value common

stock. On January 2, 2016, the corporation sold at par value the entire 5,000 authorized shares

of 8 percent, $100 par value cumulative preferred stock. On January 2, 2017, the company again

Problem Set A 513

needed capital and issued 5,000 shares of an authorized 10,000 shares of no-par cumulative preferred

stock for a total of $512,000. The no-par shares have a stated dividend of $9 per share.

The company declared no dividends in 2015 and 2016. At the end of 2016, its retained earnings

were $170,000. During 2017 and 2018 combined, the company earned a total of $890,000. Dividends

of 50 cents per share in 2017 and $1.60 per share in 2018 were paid on the common stock.

Instructions

a. Prepare the stockholders’ equity section of the balance sheet at December 31, 2018. Include a

supporting schedule showing your computation of retained earnings at the balance sheet date.

(Hint: Income increases retained earnings, whereas dividends decrease retained earnings.)

b. Assume that on January 2, 2016, the corporation could have borrowed $500,000 at 8 percent

interest on a long-term basis instead of issuing the 5,000 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

a.

Authorized Share: Common stock of 200,000 shares at $2 par value Preference stock of 10,000 shares of $100 par value
Issued and Outstanding:
Common stock of 100,000 shares at $2 par value	200,000
8% Preference stock of 5000 shares of $100 par value	500,000
Additional Paid in Capital
Common Stock [$8 - $2 ]*100,000 (Issue price - par value)	600,000
Preference shares - no par value	512,000
Total Paid in Capital		1,812,000
Retained Earnings		640,000
Total Stockholders Equity		2,452,000
Retained earnings at the end of 2016	170,000
Add:Profits for 2017 & 2018	890,000
Less:Dividend on no par preference stock [5,000 shares * $9 * 2 years]	90,000
Less: Dividend on par value preference stock [500,000*8%*3 years]	120,000
Less: Dividend on common stock for 2017 [100,000*0.5]	50,000
Less: Dividend on common stock for 2018 [100,000*1.6]	160,000
Retained earnings at the end of 2018	640,000

b. Two reasons are as below

(i) The dividend on preference stock is payable only if the company has profits but for debt the obligation is mandatory irrespective of profits.

(ii) The redemption period available for preference stock is longer when compared to debt hence it does not pose major burden for the company to pay off the funds borrowed.