(Stock and Cash Dividends) Earnhart Corporation has outstanding 3,000,000 shares of common stock with a par value of \(10 each. The balance in its Retained Earnings account at January 1, 2017, was \)24,000,000, and it then had Paid-in Capital in Excess of Par—Common Stock of \(5,000,000. During 2017, the company’s net income was \)4,700,000. A cash dividend of \(0.60 a share was declared on May 5, 2017, and was paid June 30, 2017, and a 6% stock dividend was declared on November 30, 2017, and distributed to stockholders of record at the close of business on December 31, 2017. You have been asked to advise on the proper accounting treatment of the stock dividend.

The existing stock of the company is quoted on a national stock exchange. The market price of the stock has been as follows.

October 31, 2017 \)31

November 30, 2017 \(34

December 31, 2017 \)38

Instructions

1. Prepare the journal entry to record the declaration and payment of the cash dividend.
2. Prepare the journal entry to record the declaration and distribution of the stock dividend.
3. Prepare the stockholders’ equity section (including schedules of retained earnings and additional paid-in capital) of the balance sheet of Earnhart Corporation for the year 2017 on the basis of the foregoing information. Draft a note to the financial statements setting forth the basis of the accounting for the stock dividend, and add separately appropriate comments or explanations regarding the basis chosen.

Step by step solution

01

Meaning of Stockholders Equity

Stockholders' equity refers to a company's net worth. This primarily includes common stock, paid-in capital, and retained earnings. As shareholder's equity increases, the balance sheet also reflects a sound financial report.

02

Preparing Journal Entries to record the declaration and payment of the cash dividend (a)

Date	Particular	Debit ($)	Credit ($)
May 5, 2017	Retained Earnings	1,800,000
	Dividends Payable		1,800,000
June 30, 2017	Dividend Payable	1,800,000
	Cash		1,800,000

Working Notes:

$$\begin{gathered} \mathrm{Dividend}\mathrm{Payable}=\mathrm{Shares}\times \mathrm{per}\mathrm{value}\mathrm{of}\mathrm{share} \\ =3,000,000\times \$0·60 \\ =1,800,000 \end{gathered}$$

03

Preparing Journal Entries to record the declaration and payment of the stock dividend (b)

Date	Particular	Debit ($)	Credit ($)
Nov. 30, 2017	Retained Earnings	6,120,000
	Common Stock Dividend Distributable		1,800,000
	Paid-in Capital in Excess of Par common stock		4,320,000
	To record the declaration of dividend.
December 31, 2017	Common Stock Dividend Distributable	1,800,000
	Common Stock		1,800,000
	To record the payment of dividends.

Working Notes:

$$\begin{gathered} \mathrm{Retained}\mathrm{Earnings}=\mathrm{Shares}\times \mathrm{Per}\mathrm{share}\mathrm{value}\times \mathrm{Stock}\mathrm{rate} \\ =3,000,000\times 34\times 6\% \\ =3,000,000\times 34\times \frac{6}{100} \\ =6,120,000 \end{gathered}$$

04

Preparing Stockholders Equity

EARNHART CORPORATION Stockholders’ Equity December 31, 2017
Common Stock -$10 par value, issued 3,180,000 shares	$31,800,000
Additional paid-in capital	9,320,000
Retained Earnings	20,780,000
Total Stockholders’ equity	$61,900,000

Statement of Retained Earnings For the Year Ended December 31, 2017
Balance, January 1 Add: Net Income	$24,000,000 4,700,000
Less: Dividends on common stock: Cash $1,800,000 Stock 6,120,000	7,920,000
Balance December 31	$20,780,000

Schedule of Additional Paid-in Capital For the Year Ended December 31, 2017
Balance January 1	$5,000,000
Excess of fair value over the par value of 180,000 shares of common stock Distributed as a dividend	4,320,000
Balance December 31	$9,320,000

Note:

180,000 shares of 6% stock dividend were issued on 30 November 2017. The shares were allotted for dividend purposes at a price of $34. Common stock was allotted with a par value of $10 per share ($1,800,000). Whereas, shares allocated to paid-up capital exceeding $24($34-$10) of like stock is $4,320,000.

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