Question

(Issuance of Stock for Land) Martin Corporation is planning to issue 3,000 shares of its own $10 par value common stock for two acres of land to be used as a building site.

Instructions

1. What general rule should be applied to determine the amount at which the land should be recorded?
2. Under what circumstances should this transaction be recorded at the fair value of the land?
3. Under what circumstances should this transaction be recorded at the fair value of the stock issued?
4. Assume Martin intentionally records this transaction at an amount greater than the fair value of the land and the stock. Discuss this situation.

Short answer

Martin Corporation has applied the general rule of recording assets at market price level at the time stock is granted. It was also involved in the issuance of stock in exchange for nonmonetary assets.

Step-by-step solution

Meaning of Common stock

Common stock is represented as the owner of the company, who selects the board of directors andreceives voting benefits on corporate policies. In the liquidation of the company, common shareholders are paid after the preferred shareholders.

Explaining transaction (a)

When stock is issued in exchange for services or property other than cash, the general rule is that the asset or services are recorded at market price value at the time the stock is granted, whichever can be more explicitly determined.

Explaining transaction (b)

Market price value of the land is used as the basis for registration of the transaction if it is easily determined. Market price value of an asset can be estimated by analyzing cash sale prices or through an independent appraisal.

Explaining transaction (c)

If market price value of the land cannot be determined but market price value of the stock issued can be, then market price value of the stock is used to record the exchange. If the stock is traded on a stock exchange, the fair value can be calculated using that day's cash sales. Recent sales or bid prices might be used to assess market price value if the stock is traded over the counter.

Explaining transaction (d)

If Martin reports this transaction at a price that is higher than its fair worth, both assets and stockholders' equity will be exaggerated. Watered stock refers to the overvaluation of stockholders' equity as a result of the inflated asset value. This surplus can be removed by depreciating the overpriced assets and charging the equivalent amount to the relevant paid-in capital accounts.