Lambert Corporation issued 1,000 shares of $100 par value, 8 percent, cumulative, nonpartic¬ ipating preferred stock for $100 each. The stock is preferred to assets, redeemable after five years at a prespecified price, and the preferred stockholders do not vote at the annual stock¬ holders’ meeting. The condensed balance sheet of Lambert prior to the issuance follows. Assets Total assets $580,000 Liabilities $250,000 _ Stockholders’ equity 330,000 Total liabilities and $580,000 stockholders’ equity $580,000 Chapter 12 Stockholders’ Equity 629 P1 2-2 (The effects oftreasury stock transactions on importantfinancial ratios) PI 2-3 (The significance ofpar value) PI 2-4 (Cash and stock dividends) Lambert has entered into a debt agreement that requires the company to maintain a debt equity ratio of less than 1:1. REQUIRED:

a. Provide the journal entry to record the preferred stock issuance, and compute the resulting debt/equity ratio, assuming that the preferred stock is considered an equity security.

b. Compute the debt/equity ratio, assuming that the preferred stock is considered a debt security.

c. What incentives might the management of Lambert have to classify the issuance as equity instead of debt? Do you think that the issuance should be classified as debt or equity? What might Lambert’s external auditors think?