Question

Answer the following questions.

1. What effect does the issuance of stock at a price above par value have on the issuer’s net income? Explain.

2. Why is common stock usually not issued at a price that is less than par value?

3. For what reasons might a company like IBM repurchase some of its stock (treasury stock)?

4. Diaz Inc.’s common stock has a par value of $1 and a current market price of $15. Explain why these amounts are different.

5. How does the balance sheet for a corporation differ from the balance sheet for a proprietorship?

Answer 1

• Answer 1

The issuance of stock at a price above par value will have NO EFFECT on the issuer’s Net Income.

This is because when stock is issued at a price higher than the par value, the excess amount gets credited to “Additional paid in capital in excess of par” account which forms part of the ‘paid up capital’ section of the Stockholder’s Equity of Balance Sheet. Also, Cash is debited with full amount received from issuance and Common Stock gets credited by the amount of Par Value.

No account which belong to Income Statement gets affected by such issue and hence it does not effect the issuer’s Income.

• Answer 2

Common Stock are usually not issued at a price that is less than par value because of:

                --statutory limitations,
                ---corporations do not want to issue their stock at a price below par value to demean their value.
                ---Paid Up Capital will be lower.
                ---Excess funds that could have been received will not be received.

• Answer 3

Company repurchase some of its Stock because:

>they want to re-absorbs the portion of its ownership that was distributed among various stockholders.
>there may be excess cash balance available with the company and want to use that excess cash. This is because unused cash is costly.
>they want to stabilities the stock price in the market and protect stock from being undervalued.
>they want to increase their Earnings per share, (as the no. of shares outstanding decreases).

• Answer 4

Par Value and Market price are different because:

>Stock are generally first issued at par value, and as the company grows, its market value increases and hence the market price per share also increases.

>the law of demand and supply. Good performing company with fantastic results provide better return and dividend to its stockholder’s. As a result its demand of shares in market increases, which results in higher market price.

• Answer 5

The balance sheet for a corporation differs from the balance sheet for a proprietorship as:

>Equity Section of Corporations include Common Stock, paid in Capital, Retained earnings; whereas under Proprietorship Equity Section includes Owner’s Equity – Owner’s Capital, Owner’s Withdrawals.

>Dividend is adjusted in retained earnings of Corporation’s balance sheet. No Dividend issue is used in relation to Proprietorship business.

>Corporations balance sheet is more classified and formatted as compared to Propreitorship’s.

>Treasury Stock might be appearing on Corporation’s balance sheet, while it does get reflected or used in proprietorship’s balance sheet.