Question

Issue 50,000 common shares at $10 per share to private investors. Liam currently has 100,000 common shares outstanding, with his wife holding half and Liam holding half. He also has 5,000 preferred shares outstanding. They are all owned by his father and are cumulative, paying a dividend of $4 per share. For the first time, no dividends were paid last year. It would be expected that a $100,000 dividend would be declared on November 1 of this year with a payment date of February 1. Liam would like the journal entry for the issuance of the shares and any dividend entries for this year under the assumption the dividend does get declared. Please, show calculations and Journal entries. What would be the tax implications?

Answer 1

Journal entry :

Issue of common stock in book of company.

Cash / Bank A/C DR. $500,000.

To common stock A/C $500,000.

(Being issuing common stock worth $10 so, 50,000 ×10 = $500,000.

Issue of common stock in book of investors

Investors A/C Dr. $500,000.

To cash/ bank A/C $500,000

( Being recording the investment by investors ).

Dividend :

First preference stock dividend will be declared as it is cumulative in nature which means dividend which is not declared in previous year will paid before equity shares dividends in subsequent years.

Calculation of dividend

$100,000 out of which

Dividend to preference shareholders

5000 shares × 4 per share dividend rate.

$20,000 dividend per year.

But as it was not declared in previous year. It will be culmulate that means

$20,000 for previous year.

$20,000 for current year.

Remaining will be equity shares dividend.

Dividend entries

In books of company

November 1.

Retained earnings A/C DR. $100,000.

To preference stock dividend payable A/C. $40,000

To equity stock dividend payable A/C $60,000.

(Being dividend is declared)

February 1.

Preference stock dividend payable A/C $40,000

Equity stock dividend payable A/C $60,000

To cash / bank A/C $100,000.

(Being dividend paid ).

In books of shareholders

Preference shareholders

November 1

Dividend receivable A/C DR. $40,000.

To dividend income A/C $40,000

(Being dividend decleared)

February 1.

Cash / Bank A/C dr. $40,000.

To dividend receivable A/C $40,000.

Equity shareholders

Calculation

Total dividend $60,000

Total share outstanding 150,000 out of which 100,000 shares owned Liam and his wife equally and $50,000 for private investor.

Dividend for private investors $60,000 ×50,000 /150,000.

$20,000.

Dividend between liam and his wife $40,000 in equal proportion

In book of liam and his wife.

November 1.

Equity shares dividend receivable A/C dr. $40,000

To dividend income A/C $40,000.

(Being dividend declared)

February 1.

Cash / Bank A/C dr. $40,000.

To equity shares dividend receivable A/c $40,000.

(Being dividend paid )

ALTERNATIVELY

Separate entry can be done with 20,000 amount as both husband and wife owns half shares.

TAX CONSEQUENCES

1. ISSUE OF SHARES:

As per section 351 it is non taxable transaction to both the corporation and shareholders both

2. Dividend declaration

No tax liability on both corporations and investors.

3. Dividend received/paid

This is applicable to both equity and preference dividend

Dividend is taxable to shareholders. When received.

Dividend is not tax deductible to corporation

Dividend received from us corporation may be treated as qualified dividend in which tax rates will be same as long term capital gain rate other wise it will be ordinary tax rate.

Other conditions besides receipt from USA corporation

- Stock held for over 60 days during the 121 days periods that begins 60 days before ex-dividend date.