Question

Part Two: Because Natalie has been so successful with Cookie Creations and Curtis has been just as successful with his coffee shop, they both conclude that they could benefit from each other’s business expertise. Curtis and Natalie next evaluate the different types of business organization, and because of the advantage of limited personal liability, decide to form a new corporation. 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 as a location for her cookie-making classes and demonstrations of the mixers that she sells. Natalie will also hire, train, and supervise staff hired to bake cookies and muffins sold in the coffee shop. By offering her classes on the premises, Natalie will save on travel, and the coffee shop will provide one central location for selling the mixers. Combining forces will also allow Natalie and Curtis to pool their resources and buy a few more assets to run their new business venture. The current market values of the assets of both businesses are as follows. Description Curtis’ Coffee Cookie Creations Cash $ 7,500 $12,000 Accounts receivable 100 500 Merchandise inventory 450 1,130 Equipment 2,500 1,000 $10,550 $14,630 Curtis and Natalie meet with a lawyer and form their corporation, called Cookie & Coffee Creations Inc., on November 1, 2018. The new corporation is authorized to issue 50,000 shares of $1 par common stock and 10,000 shares of no par, $6 cumulative preferred stock. The assets held by each business will be transferred into the corporation at current market value of $1 per share. Curtis will receive 10,550 common shares, and Natalie will receive 14,630 common shares in the corporation. Natalie and Curtis are very excited about this new business venture. They come to you with the following questions. 1. Curtis’ dad and Natalie’s grandmother are interested in investing $5,000 each in the new business venture. Curtis and Natalie are considering issuing them preferred shares. What would be the advantage of issuing them preferred stock instead of common? 2. What would be the advantages and disadvantages of issuing cumulative preferred? 3. “Our lawyer sent us a bill for $750. When we talked the bill over with her, she said she would be willing to receive common stock in our corporation instead of cash. We would be happy to issue her stock, but we’re 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 Natalie and Curtis’ questions.

b) Prepare the journal entries required on November 1, 2018, 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 $6 cumulative preferred shares to Curtis’ 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 required for each of these transactions that also occurred on November 1.

(d) Prepare the opening balance sheet for Cookie & Coffee Creations Inc. as of November 1, 2018, including the journal entries in (b) and (c) above.

Answer 1

A. 1. Advantages of Preferred stock over common.

a. No Dilution of Equity - one of the most important advantage of preferred stock is that preference shareholder's are not the owners of the company and therefore, there is no dilution of common stock. This also result in satisfaction of other shareholder's as their proportion of the ownership in the company is not reduced.

b. No voting rights - Preference shareholders are not entitled to the voting rights in the company unless & until the fixed dividends is not paid to them. Due to this, they cannot involve themselves in the decisions of the company.

c. Less return to preference shareholder's - Since the preference shareholder's rank above the common equity in terms of dividend payment & capital repayment, they are provided less return as compared to shareholders as they have security over the repayment. Less risk is borne by preference shareholder's.

d. No Charge on Assets- Preference shares do not create any mortgage or charge on the assets of the company. The company can keep its fixed assets free for raising loans in future.

2. Cumulative Preference shares

Advantages

a. Under cumulative preference shares, if dividends are not paid in a year then such dividends gets cumulated & are required to be paid by the company in the year in which it pays dividends along with that year dividends. Therefore, fixed dividends of the preference shareholders is not lapse if the same are unpaid.

b. No fixed obligation on the company- A company is not bound to pay dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is created on its finances.

Disadvantages.

a. In case company, fixed dividends are not paid in for 2 or more year, then shareholders can claim voting rights in the company and have the right to vote at all the meetings of the company.

b. Limited Appeal - Bold investors do not like preference shares. Cautious and conservative investors prefer debentures and government securities. In order to attract sufficient investors, a company may have to offer a higher rate of dividend on preference shares.

3. Issue of stock for legal bill

Yes, Curtis and Natalie can issue common stock to the lawyer in lieu of the legal bill of $750. In such case, the market value of the stock is usually considered for calculating the number of common stocks to be issued by company. In the given case, current market value of share is given as $1 per share and therefore, the company will issue 750 common stock.

Journal Entry

Legal Expenses...........DR. 750

TO Common Stock (750 shares) .......... 750