The Proportional and Incremental methods are two ways companies can allocate the lump sum total earned on a sale of multiple securities.
General Scenario
ABC Corporation has issued 500 shares of both common and preferred stock in exchange for a lump sum of $100,000. This package included 350 shares of common stock which have a par value of $150 and a market value of $175 per share. The remaining 150 shares in the package were preferred stock which have a par value of $180 and a market value of $200 per share.
Record the transaction above in the appropriate journal entry.
Proportional Method
Step 1 – Reorganize the Information into a Clear and Usable Format
| Stock | Quantity | Total Par Value | Fair Value Per Share |
|---|---|---|---|
| Common Stock | 350 | 350Q x $150 = $52,500 | 350Q x $175 = $61,250 |
| Preferred Stock | 150 | 150Q x $180 = $27,000 | 150Q x $200 = $30,000 |
The company will allocate the $100,000 lump payment based on the % each security has of the total fair market value. This is generally the preferred method if the fair market value is available.
Step 2 – Calculate the Allocation Rate
| Security | Fair Market Value | Total | % of Total $91,250 |
|---|---|---|---|
| 350 Shares of Common Stock | 350Q x $175 | $61,250 | 67.12% |
| 150 Shares of Preferred Stock | 150Q x $200 | $30,000 | 32.88% |
| TOTAL FAIR MARKET VALUE | $91,250 | 100% |
Step 3 – Calculate the Allocation of the Lump Sum Payment
| Security | Allocation Rate | Lump Sum Payment | Allocation of Lump Sum |
|---|---|---|---|
| 350 Shares of Common Stock | 67.12% | $100,000 | $67,120 |
| 150 Shares of Preferred Stock | 32.88% | $100,000 | $32,880 |
Step 4 – Record the Journal Entry
The purpose of this journal entry is to allocate the cash received (asset) according to the proper sources of that cash. In this case, the cash originated from the sale of equity (preferred stock and common stock).
Assets (Δ+$100,000) = Liabilities (Δ0) + Equity (Δ+$100,000)
The Balance Sheet remains Balanced. ✓
Based on the allocation assigned above, $67,120 of the sum is assigned to the common stock and the remaining $32,880 is assigned to the preferred stock for the total of $100,000 cash received.
When entering this sale of common or preferred stock into the balance sheet, there are five key accounts you may need. In addition to the cash and stock accounts, you will also need the APIC (Additional Paid in Capital) accounts to record any of the remaining allocation beyond the par value.
| Account | Explanation | Debit | Credit |
|---|---|---|---|
| Cash | The money received | $100,000 | |
| Common Stock | The Par Value of the common stock that was issued. | $52,500 | |
| Preferred Stock | The Par Value of the preferred stock that was issued. | $27,000 | |
| Additional Paid in Capital in Excess of Par – Common | Allocated Value of Common Stock ($67,120) – Par Value already recorded | $14,620 | |
| Additional Paid in Capital in Excess of Par – Preferred | Allocated Value of Preferred Stock ($32,880) – Par Value already recorded | $5,880 |
The entry below would also include the date and account numbers.
| Accounts & Explanations | Debit | Credit |
|---|---|---|
| Cash | $100,000 | |
| Common Stock | $52,500 | |
| Preferred Stock | $27,000 | |
| APIC in Excess of Par – Common | $14,620 | |
| APIC in Excess of Par – Preferred | $5,880 | |
| Record the sale of 350 shares of common stock with a par of $150 and 150 shares of preferred stock with a par of $180. | ||
| Total | $100,000 (D) | $100,000 (C) |
Incremental Method
For this method to make sense, we will first modify our example above to remove some information that is no longer available to the corporation.
ABC Corporation has issued 500 shares of both common and preferred stock in exchange for a lump sum of $100,000. This package included 350 shares of common stock which have a par value of $150 and a market value of $175 per share. The remaining 150 shares in the package were preferred stock which have a par value of $180 and but where the fair market value is not available.
Record the transaction above in the appropriate journal entry.
The Incremental Method is convenient where one of the securities does not have a readily known fair market value. The steps and approach of the Incremental Method are the same as that of the Proportional Method except in Step 2 – identifying the allocation rate. This step involved the use of fair market values and thus something has to change when that information is not available.
Step 1 – Reorganize the Information into a Clear and Usable Format
The question has slightly changed so we need to re-identify the information that is available.
| Stock | Quantity | Total Par Value | Fair Value Per Share |
|---|---|---|---|
| Common Stock | 350 | 350Q x $150 = $52,500 | 350Q x $175 = $61,250 |
| Preferred Stock | 150 | 150Q x $180 = $27,000 | ? |
Step 2 – Calculate the Allocation Rate
The company still wants to allocate the $100,000 lump payment but the situation is now more complex. Instead, they will use the fair market value of the securities where it is known, but then allocate according to the lump sum rather than the total fair market value.
*Note in the table below that the % in the Incremental Method is of the lump sum ($100,000) whereas the Proportional Method was calculating the % out of the total fair market value of the securities ($91,250).
| Security | Fair Market Value | Total | % of Total $100,000 |
|---|---|---|---|
| 350 Shares of Common Stock | 350Q x $175 | $61,250 | 61.25% |
| 150 Shares of Preferred Stock | ? | $38,750 | 38.75% |
| TOTAL LUMP SUM | $100,000 | 100% |
Step 3 – Calculate the Allocation of the Lump Sum Payment
| Security | Allocation Rate | Lump Sum Payment | Allocation of Lump Sum |
|---|---|---|---|
| 350 Shares of Common Stock | 61.25% | $100,000 | $61,250 |
| 150 Shares of Preferred Stock | 38.75% | $100,000 | $38,750 |
Step 4 – Record the Journal Entry
Again, the cash originated from the sale of equity (preferred stock and common stock).
Assets (Δ+$100,000) = Liabilities (Δ0) + Equity (Δ+$100,000)
The Balance Sheet remains Balanced. ✓
Based on the allocation assigned above, $61,250 of the sum is assigned to the common stock and the remaining $38,750 is assigned to the preferred stock for the total of $100,000 cash received.
Par value has not changed, so this will be the same as with the Proportional Method. It is simply the Additional Paid in Capital that will now change.
| Account | Explanation | Debit | Credit |
|---|---|---|---|
| Cash | The money received | $100,000 | |
| Common Stock | The Par Value of the common stock that was issued. | $52,500 | |
| Preferred Stock | The Par Value of the preferred stock that was issued. | $27,000 | |
| Additional Paid in Capital in Excess of Par – Common | Allocated Value of Common Stock ($61,250) – Par Value already recorded | $8,750 | |
| Additional Paid in Capital in Excess of Par – Preferred | Allocated Value of Preferred Stock ($38,750) – Par Value already recorded | $11,750 |
The entry below would also include the date and account numbers.
| Accounts & Explanations | Debit | Credit |
|---|---|---|
| Cash | $100,000 | |
| Common Stock | $52,500 | |
| Preferred Stock | $27,000 | |
| APIC in Excess of Par – Common | $8,750 | |
| APIC in Excess of Par – Preferred | $11,750 | |
| Record the sale of 350 shares of common stock with a par of $150 and 150 shares of preferred stock with a par of $180. | ||
| Total | $100,000 (D) | $100,000 (C) |
Disclaimer: Nothing in this article is to be relied upon as legal or professional advice – it considers only general scenarios. Every individual faces a unique situation and requires personalized and targeted professional and legal assistance. If you are looking for advice, speak with a professional and find what applies directly to you. Blessing Associates is not liable for any results that arise should you rely solely upon information in this article.
DISCLAIMER:
The information offered through our Services is general information only and may not apply to every individual. We make no warranties or promises regarding the accuracy, validity, reliability, availability, or completeness of the data herein. This information is not intended for reliance. Under no circumstances will Blessing Associates, LLC or its owners & operators be liable for any problems that may result from using or reading this information. Individuals with a particular issue are recommended to contact attorney’s privately for tailored solutions.
The use of the Internet or phone as means of contacting this firm or any individual attorney of this firm will not establish an attorney‐client relationship, thus do not use this form to submit confidential or time‐sensitive information. Whether you are a new or existing client of the firm, Blessing Associates, LLC cannot represent you on any new matter until the firm has made a determination that there is no conflict of interest and that it is willing and otherwise able to accept the new engagement. Unless
and until Blessing Associates, LLC has informed you it is willing and able to accept your new matter, do not send the firm any information or documents that you consider private or confidential. No attorney-client relationship is created without the formal signature of a contract and prior agreement by both parties. Continued use of our Services serves as evidence that you approve our Privacy Policies and Terms & Conditions.
