Question

On January 1, 2017, Agassi Corporation had the following stockholders’ equity accounts.

Common Stock (\(10 par value, 60,000 shares issued and outstanding) \)600,000

Paid-in Capital in Excess of Par—Common Stock 500,000

Retained Earnings 620,000

During 2017, the following transactions occurred.

Jan. 15 Declared and paid a \(1.05 cash dividend per share to stockholders

Apr. 15 Declared and paid a 10% stock dividend. The market price of the

stock was \)14 per share.

May 15 Reacquired 2,000 common shares at a market price of \(15 per share.

Nov. 15 Reissued 1,000 shares held in treasury at a price of \)18 per share.

Dec. 31 Determined that net income for the year was $370,000.

Accounting

Journalize the above transactions. (Include entries to close net income to Retained Earnings.) Determine the ending balances for Paid-in Capital, Retained Earnings, and Stockholders’ Equity.

Analysis

Calculate the payout ratio and the return on common stockholders’ equity.

Principles

R. Federer is examining Agassi’s financial statements and wonders whether the “gains” or “losses” on Agassi’s treasury stock transactions should be included in income for the year. Briefly explain whether and the conceptual reasons why gains or losses on treasury stock transactions should be recorded in income.

Short answer

The total debit and credit balance of the journal is $565,000, and the shareholder’s equity is $2,015,000. The payout ratio is 17%, and the return on ordinary share equity is 19.3%.

Step-by-step solution

Meaning of Shareholders’ Equity

Shareholders' equity (SE), also known as shareholders' value, both have the same meaning. The term refers to the sum of the value that the owners of a corporation

have left after paying off liabilities or debts. Equity basically refers to the difference between the total resources and total obligations of a company

Preparing Journal Entries

Date	Particular	Debit ($)	Credit ($)
Jan. 15, 2017	Retained Earnings	63,000
	Cash		63,000

Working Notes:

Calculation of Retained Earnings

$\begin{array}{rcl}\mathrm{Retained}\mathrm{Earnings}& =& \mathrm{Common}\mathrm{stock}\mathrm{share}\times \mathrm{cash}\mathrm{dividend}\mathrm{price}\\ & =& 60,000\times \$1.05\\ & =& 63,000\end{array}$

Date	Particular	Debit ($)	Credit ($)
April 15, 2017	Retained Earnings	84,000
	Share Capital-ordinary		60,000
	Share Premium-ordinary		24,000

Working Notes:

Calculation of Retained Earnings

$\begin{array}{rcl}\mathrm{Retained}\mathrm{Earnings}& =& \left(\mathrm{Dividend}\mathrm{Rate}\times \mathrm{Common}\mathrm{stock}\mathrm{share}\right)\times \mathrm{market}\mathrm{price}\mathrm{od}\mathrm{share}\\ & =& \left(10\%\times 60,000\right)\times \$14\\ & =& 84,000\end{array}$

Date	Particular	Debit ($)	Credit ($)
May 15, 2017	Treasury Shares	30,000
	Cash		30,000

Working Notes:

Calculation of Treasury Shares

$\begin{array}{rcl}\mathrm{Treasury}\mathrm{Shares}& =& \mathrm{Required}\mathrm{share}\times \mathrm{market}\mathrm{price}\mathrm{per}\mathrm{share}\\ & =& 2000\times \$15\\ & =& 30,000\end{array}$

Date	Particular	Debit ($)	Credit ($)
Nov. 15, 2017	Cash	18,000
	Share Premium-Treasury		3,000
	Treasury Shares		15,000

Working Notes:

Calculation of Cash amount

$\begin{array}{rcl}\mathrm{Cash}\mathrm{amount}& =& \mathrm{Shares}\times \mathrm{per}\mathrm{shares}\mathrm{value}\\ & =& 1,000\times \$18\\ & =& 18,000\end{array}$

Date	Particular	Debit ($)	Credit ($)
Dec. 31, 2017	Income Summary	370,000
	Retained Earnings		370,000

Preparing Shareholders Equity Section (Analysis)

AGASSI CORPORATION Statement of Financial Position (partial) December 31, 2017

Equity Share capital-ordinary $10 par value, 66,000 shares issued And outstanding	$ 660,000
Share premium-ordinary	527,000
Retained earnings	843,000
Treasury Shares	(15,000)
Total equity	$2,015,000

Working Notes:

Calculation of Share capital amount

$\begin{array}{rcl}\mathrm{Share}\mathrm{capital}& =& \mathrm{Common}\mathrm{stock}+\mathrm{outstanding}\mathrm{shres}\\ & =& \$600,000+\$60,000\\ & =& \$660,000\end{array}$

Calculation of Share premium amount

$\begin{array}{rcl}\mathrm{Share}\mathrm{premium}& =& \mathrm{Paid}-\mathrm{in}\mathrm{capital}\mathrm{in}\mathrm{excess}\mathrm{of}\mathrm{par}+\mathrm{Share}\mathrm{premium}\mathrm{ordinary}+\mathrm{Share}\mathrm{premium}\mathrm{treasury}\\ & =& \$500,000+24,000+3,000\\ & =& \$527,000\\ & & \end{array}$

Calculation of Retained Earnings

$\begin{array}{rcl}\mathrm{Retained}\mathrm{Earnings}\mathrm{Amount}& =& (\mathrm{Cjhange}\mathrm{in}\mathrm{the}\mathrm{value}\mathrm{of}\mathrm{retained}\mathrm{eaarnings})+\mathrm{met}\mathrm{income}\\ & =& (\$620,000-\$63,000-\$84,000)+370,000\\ & =& \$843,000\end{array}$

Calculation of Treasury Shares

$\begin{array}{rcl}\mathrm{Treasury}\mathrm{shares}& =& \mathrm{Treasury}\mathrm{shares}\mathrm{issued}-\mathrm{Treasury}\mathrm{shares}\mathrm{paid}\\ & =& \$30,000-\$15,000\\ & =& \$15,000\end{array}$

Analysis of Payout Ratio

$\begin{array}{rcl}\mathrm{Payout}\mathrm{ratio}& =& \frac{\mathrm{Total}\mathrm{dividend}}{\mathrm{Net}\mathrm{income}}\\ & =& \frac{\$63,000}{\$370,000}\\ & =& 17\%\end{array}$

Analysis of ordinary share equity

$\begin{array}{rcl}\mathrm{Return}\mathrm{on}\mathrm{ordinary}\mathrm{share}\mathrm{equity}& =& \frac{\mathrm{Net}\mathrm{income}}{\mathrm{Average}\mathrm{shareholder}\mathrm{equity}}\\ & =& \frac{\$370,000}{{\displaystyle \frac{\$1,720,000+\$2,105,000}{2}}}\\ & =& 19.3\%\end{array}$

Explaining the conceptual reasons why gains or losses on treasury stock transactions should be recorded in income.

As treasury stock does not fit the definition of an asset, it does not result in gains or losses when it is sold above or below cost. It is rather unissued equity. Furthermore, as share repurchases and reissues are transactions with their own owners, no profits or losses should be recorded; the effect of such transactions should not be reflected in income.