Question

Part 1: answer (a), (b), (c), and (d).

Part 2: answer (a), (b), (c), and (d). Godspeed, and good luck!!!

CC11 Cookie Creations

Natalie and her friend Curtis Lesperance decide that they can benefit from joining Cookie Creations and Curtis’s coffee shop. In the first part of this problem, they come to you with questions about setting up a corporation for their new business. In the second part of the problem, they want your help in preparing financial information following the first year of operations of their new business, Cookie & Coffee Creations.

Part 1

Curtis has operated his coffee shop for 2 years. He buys coffee, muffins, and cookies from a local supplier. Natalie’s business consists of giving cookie-making classes and selling fine European mixers. The plan is for Natalie to use the premises Curtis currently rents to give her cookie-making classes and demonstrations of the mixers that she sells. Natalie will also hire, train, and supervise staff to bake the cookies and muffins sold in the coffee shop. By offering her classes on the premises, Natalie will save on travel time going from one place to another. Another advantage is that the coffee shop will have one central location for selling the mixers.

The current market values of the assets of both businesses are as follows.

Curtis’s Coffee Cookie Creations

Cash $7,500 $11,630

Accounts receivable 100 800

Inventory 450 1,200

Equipment 2,500 1,000*

*Cookie Creations decided not to buy the delivery van considered in Chapter 9.

Combining forces will also allow Natalie and Curtis to pool their resources and buy a few more assets to run their new business venture.

Curtis and Natalie then meet with a lawyer and form a corporation on November 1, 2016, called Cookie & Coffee Creations Inc. The articles of incorporation state that there will be two classes of shares that the corporation is authorized to issue: common shares and preferred shares. They authorize 100,000 no-par shares of common stock,

and 10,000 no-par shares of preferred stock with a $0.50 noncumulative dividend.

CC11 (Continued)

The assets held by each of their businesses will be transferred into the corporation at current market value. Curtis will receive 10,550 common shares, and Natalie will receive 14,630 common shares in the corporation.

Therefore, the shares have a fair value of $1 per share.

Natalie and Curtis are very excited about this new business venture. They come to you with the following questions:

1. “Curtis’s dad and Natalie’s grandmother are interested in investing $5,000 each in the business venture. We are thinking of issuing them preferred shares. What would be the advantage of issuing them preferred shares instead of common shares?”

2. “Our lawyer has sent us a bill for $750.When we discussed the bill with her, she indicated that she would be willing to receive common shares in our new corporation instead of cash for her services. We would be happy to issue her shares, but we’re a bit worried about accounting for this transaction. Can we do this? If so, how do we determine how many shares to give her?”

Instructions

(a) Answer their questions.

(b) Prepare the journal entries required on November 1, 2016, the date when Natalie and Curtis transfer the assets of their respective businesses into Cookie & Coffee Creations Inc.

(c) Assume that Cookie & Coffee Creations Inc. issues 1,000 $0.50 noncumulative preferred shares to Curtis’s dad and the same number to Natalie’s grandmother, in both cases for $5,000. Also assume that Cookie & Coffee Creations Inc. issues 750 common shares to its lawyer. Prepare the journal entries for each of these transactions. They all occurred on November 1.

(d) Prepare the opening balance sheet for Cookie & Coffee Creations Inc. as of November 1, 2016, including the journal entries in (b) and (c) above.

CC11 (Continued)

Part 2

After establishing their company’s fiscal year-end to be October 31, Natalie and Curtis begin operating Cookie & Coffee Creations Inc. on November 1, 2016. On that date, after the issuance of shares, the paid-in capital section of the company’s balance sheet is as follows.

Paid-in capital

Preferred stock, $0.50 noncumulative, no par value,

10,000 shares authorized, 2,000 shares issued $10,000

Common stock, no par value, 100,000 shares

authorized, 25,930 shares issued 25,930

Cookie & Coffee Creations then has the following selected transactions during its first year of operations.

Dec. 1 Issues an additional 800 preferred shares to Natalie’s brother for $4,000.

Apr. 30 Declares a semiannual dividend to the preferred stockholders of record on May 15, payable on June 1.

June 30 Repurchases 750 shares of common stock issued to the lawyer, for $500. Recall that these were originally issued for $750. The lawyer had decided to retire and wanted to liquidate all of her assets.

Oct. 31 The company has had a very successful first year of operations. It earned revenues of $462,500 and incurred expenses of $364,050 (including $750 legal fee, but excluding income tax).

31 Records income tax expense. (The company has a 20% income tax rate.)

31 Declares a semiannual dividend to the preferred stockholders of record on November 15, payable on December 1.

Instructions

(a) Prepare the journal entries to record the above transactions.

(b) Prepare the retained earnings statement for the year.

(c) Prepare the stockholders’ equity section of the balance sheet as of October 31.

(d) Prepare closing entries.

Answer 1

Part 1:

a. 1. The advantage of issuing preference shares instead of common stock from the company's point of view is that there would be no further dilution of ownership. Although preference shares are entitled to a certain amount of dividend, they do not have voting rights or ownership like equity shares do.

2. Shares can be issued instead of settling the bill by cash. The accounting entry would be debiting the Lawyer's personal account and crediting the common stock account. Since the fair value per share is $1 and the amount to be paid is 750$, the number of shares to be issued would be 750.

b. Journal entries in the books of Cookie and Coffee Creations Inc (Transferee) as on November 1, 2016

Cash A/c Dr. 19,130

Accounts Receivable A/c Dr. 900

Inventory A/c Dr. 1,650

Equipment A/c Dr. 3,500

To Common stock A/c 25,180

All the above figures are sums of the individual assets transferred at current market value from both the businesses.

c. Journal entry for issue of preference stock

Cash A/c Dr. 10,000

To Prefered Stock A/c 10,000

Journal Entry for payment to Lawyer through shares

Retained Earnings A/c Dr. 750

To Common stock A/c 750

d.

Balance Sheet

Particulars	Amount
Assets
Cash	29,130
Accounts Receivable	900
Inventory	1,650
Equipment	3,500
Total Assets	35,180
Net Stockholder's equity	25,180
Preferred Stock	10,000
Total Capital	35,180

Net Stock holder's equity = Total common stock issued + Retained earnings impact(profit/loss) = (10,550+14,630+750) - 750 = 25,180

Part 2

a. Journal entries

12/01 For issuance of preferred stock to Natalie's brother

Cash A/c Dr. 4,000

To preferred stock A/c 4,000

04/30 For declaration of semi annual dividend to preference stock holders

Retained Earnings A/c Dr. 700

To Preference Dividend payable A/c 700

The amount is derived as follows: For every share, the dividend is 0.5$. As of 30th April there are 2,800 preference shareholders on record. Since the total amount of dividend would $1,400 in thar case and the company is paying a semi annual dividend, the amount would be $700.

06/01 Payment of Dividend to preference share holders

Preference Dividend payable A/c Dr. 700

To Cash A/c 700

06/30 Repurchase of shares from lawyer

Common stock A/c Dr. 750

To Retained earnings A/c 250

To Cash A/c 500

10/31 Revenues earned

Cash A/c Dr. 462,500

To Retained Earnings A/c 462,500

10/31 Expenses incurred excluding income tax and legal fee

Retained Earnings A/c Dr. 363,300

To Cash A/c 363,300

10/31 Recording of Income Tax

Retained Earnings A/c Dr. 19,740

To Income Tax Payable A/c 19,740

10/31 Retained Earnings A/c Dr. 700

To Preference Dividend payable A/c 700

b. Retained Earnings Statement

To Cash(Expenses other than legal fee)	3,63,300	By Cash(Revenue)	4,62,500
To Income Tax payable	19,740	By common stock (buyback of stock)	250
To Preference Dividend payable (June)	700
To Preference Dividend payable(Dec)	700
To common stock (paid to lawyer through stock)	750
To closing balance	77,560
	462,750		462,750

c. Stockholder's equity section of the balance sheet as of October 31

Common stock	25,180
Retained earnings	77,560
Total Stockholder's equity	102,740

d. Balance Sheet

Particulars	Amount
Assets
Cash	131,130
Accounts Receivable	900
Inventory	1,650
Equipment	3,500
Total	137,180
Liabilities
Income Tax payable	19,890
Preference Dividend Payable	700
Capital
Prefered Stock	14,000
Total Stockholder's equity	102,740
Total Liabilites and Capital	137,180