Chapter 13 Case 1 Answers
Case 1: Change of stockownership does not affect a corporations' general ledger accounts. Regardless of who owns the stock, the stock is still listed on the corporation's records as outstanding stock. No journal entry is made for stock transfer.
Case 2: Bonds : (a) The corporation must pay a total of $60,000.00 interest each year for ten years. This payment reduces the amount of net income available for stock dividends, and for future use of the corporation. also, the corporation must pay a additional $60,000.00 into a bond sinking fund each year for ten years. This means that the entire $600,00.00 is not available for use throughout the the years. At the end of ten years, the money in the bond sinking fund must be returned to the investors. (b) The $600,000.00 is not a permanent investment in the business. If, at the end of ten years the additional earnings have not been as great as predicted., the corporation might still need the money but still must return the money to the bondholders. The investment is temporary. (c) Owners of bonds do not have a vote in stockholders' meetings. Control of the corporation is retained by the current owners of common stock.
2. Preferred Stock: (a) An annual dividend of $60,000.00 is required before any dividends can be paid on common stock. (b) Nothing has to be set aside each year to retire the stock, The investment in the corporation is permanent. (c) Owners of preferred stock do not have a vote in stockholders' meetings. control of the corporation is retained by current owners of common stock.
3. Common Stock: (a) Although dividends may be paid each year on the common stock, if net income is insufficient, dividends need not be paid. If the corporation continues the previous dividend rate, a total of $48,000.00 would be paid each year on the additional common stock. (b) Nothing has to be set aside each year to retire the stock.. The investment in the corporation is permanent. (c) Common stockholders have a vote in stockholder's meetings. The control of the business will be spread over more shares of stock.
Recommendation: Issue bonds. Bonds and preferred stock will not change the control by current owners of common stock. Bonds and preferred stock will increase costs for interest and dividends. However, bonds will increase the cost for only ten years. Bonds will also decrease taxes for the ten years. If the business does not anticipate paying dividends in the future, issuing common stock is the best source of additional capital. The investment would be permanent and incur no additional costs. However, few corporations anticipate that earnings will never be sufficient to pay dividends in the future. In addition, few persons are willing to pay for stock that has little chance of ever earning dividends.