If a company issues 2,500 shares of $2 par value common stock at a market price of $48 per share, which of the following is the correct financial statement effect? Increase cash by $120,000 and increase liabilities by $120,000 Increase cash by $120,000 and increase contributed capital by $120,000 Increase cash by $120,000 and increase earned capital by $120,000 Increase cash by $120,000, increase contributed capital by $60,000, and increase earned capital by $60,000
The correct answer and explanation is:
Correct Answer:
Increase cash by $120,000 and increase contributed capital by $120,000
Explanation:
When a company issues common stock, it is raising money by selling ownership shares to investors. Let’s break this down:
Details from the question:
- Number of shares issued = 2,500
- Par value per share = $2
- Market price per share = $48
Total Cash Received:
2,500 shares×$48=$120,000\text{2,500 shares} \times \text{\$48} = \text{\$120,000}
This amount is the cash inflow, as the company receives $120,000 from investors.
Accounting for Stock Issuance:
Stockholders’ equity increases, specifically in two accounts under equity:
- Common Stock (at par value):
2,500×$2=$5,0002,500 \times \$2 = \$5,000 - Additional Paid-In Capital (APIC):
($48−$2)×2,500=$115,000(\$48 – \$2) \times 2,500 = \$115,000
Together:
- Total Contributed Capital = Common Stock + APIC = $5,000 + $115,000 = $120,000
This reflects what the owners have invested in the company.
Important Notes:
- Liabilities are not affected. The company does not owe this money back; it’s an ownership transaction.
- Earned Capital (i.e., Retained Earnings) is not affected. Retained earnings come from profits, not from selling stock.
- The par value is just a legal minimum that doesn’t affect the total cash raised meaningfully.
Conclusion:
The issuance of 2,500 shares at $48 each results in:
- Cash (Asset) ↑ by $120,000
- Contributed Capital (Equity) ↑ by $120,000
No effect on liabilities or earned capital.