Question

In keeping with a modernization of corporate statutes in its home state, UMC Corporation decided in 2021 to discontinue accounting for reacquired shares as treasury stock. Instead, shares repurchased will be viewed as having been retired, reassuming the status of unissued shares. As part of the change, treasury shares held were reclassified as retired stock. At December 31, 2020, UMC’s balance sheet reported the following shareholders’ equity: 

                                                                                               ($ in millions) 

Common stock, $1 par......................................................................................$ 200 

Paid-in capital—excess of par...........................................................................800 

Retained earnings 956 Treasury stock (4 million shares at cost)..........(25) 

Total shareholders’ equity..............................................................................$1,931 

 

Required: 

Identify the type of accounting change this decision represents, and prepare the journal entry to effect the reclassification of treasury shares as retired shares.

Answer 1

Common stock:

A common stock is a share of a company\'s ownership and gives the shareholder a dividend, which vary according to the way the company does so. The benefit of using a common stock is that the sum of money you can earn is not limited. However, it is a major disadvantage if your payments get worse and are perhaps entirely disregarded.

 

Retired stock:

The shares of a corporation which are formally bought back from the shareholders for cash obtain the status of ‘authorized but unissued shares’. Such shares are referred to as retired stock.

 

Treasury stock:

The shares of a corporation which are bought back from the shareholders for cash but are not formally retired are referred to as treasury stock.

 

Journal entries:

Journal entry records the accounting transactions of a business in a journal book. All the business transactions are recorded in the chronological order using the double entry system of accounting.

 

Journalize the entry to effect the reclassification of treasury shares as retired shares.

Date	Account title & Explanation	Debit ($)	Credit ($)
2021	Common stock	4,000,000
	Paid-in-capital in excess of par	16,000,000
	Retained earnings	5,000,000
	Treasury stock		25,000,000
	[To record retirement of common stock.]

 

Explanation:

• Common Stock is a stockholders’ equity account and the amount has decreased due to re-acquisition of common stock. Therefore, debit Common Stock account with $4,000,000.

• Paid-in Capital–Excess of Par is a stockholders’ equity account and the amount has decreased due to decrease in capital. Therefore, debit Paid-in Capital–Excess of Par account with $16,000,000.

• Retained Earnings is a stockholders’ equity account. The amount has decreased because the difference due to re-acquisition is debited to this account. Therefore, debit Retained Earnings account with $5,000,000.

• Treasury Stock is a stockholders’ equity account. The amount is credited because treasury stock is reclassified as retired stock; therefore, credit Treasury Stock account with $25,000,000.

 

Working Notes:

Compute common stock value.

The common stock value is calculated by multiplying the number of shares with the par value per share as shown below:

 

Common stock value = Number of shares × Par value per share

                                     = $4,000,000 shares × $1

                                     = $4,000,000

 

 

Compute excess of par value per share.

The excess of par value per share is calculated by dividing the total paid-in-capital-excess of par value with the total common stock value as shown below:

 

Excess of par value = Total paid-in capital-excess of par value/total common stock value

                                   = $800,000,000/$200,000,000

                                   = $4

 

Compute paid-in capital in excess of par value.

The amount of paid-in capital in excess of par value is calculated as shown below:

 

Paid-in capital in excess of par value = Number of shares × Excess of par value per share

                                                            = 4,000,000 shares × $4

                                                            = $16,000,000

 

Compute retained earnings amount.

 

The retained earnings amount is calculated by deducting the common stock value and paid-in-capital-excess of par value as shown below:

 

Retained earnings amount = Treasury stock – Common stock value – Paid-in capital-excess of par value

                                                = $25,000,000 - $4,000,000 - $16,000,000

                                                = $5,000,000

 

Explanation:

• Corporation U has changed the accounting of reacquired shares by discontinuing the treasury stock.

• To make this conversion effective, the corporation revises the financial statements.

• This change should be disclosed by the corporation for the period reported.

Journalize the entry to effect the reclassification of treasury shares as retired shares.

Date	Account title & Explanation	Debit ($)	Credit ($)
2021	Common stock	4,000,000
	Paid-in-capital in excess of par	16,000,000
	Retained earnings	5,000,000
	Treasury stock		25,000,000
	[To record retirement of common stock.]