1. Financial Accounting, Sixth Edition
Chapter 12
Corporations:
Organization,
Stock Transactions,
Dividends, and
Retained Earnings
Financial Accounting, Sixth Edition

2. Study Objectives Identify the major characteristics of a corporation.
Record the issuance of common stock.
Explain the accounting for treasury stock.
Differentiate preferred stock from common stock.
Prepare the entries for cash dividends and stock dividends.
Identify the items that are reported in a retained earnings statement.
Prepare and analyze a comprehensive stockholders’ equity section.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

3. Corporations: Organization, Stock Transactions, Dividends and Retained Earnings
Corporate Organization and Stock Transactions
Dividends
Retained Earnings
Statement Presentation and Analysis
Corporate form of organization
Common stock issues
Treasury stock
Preferred stock
Cash dividends
Stock dividends
Stock splits
Retained earnings restrictions
Prior period adjustments
Retained earnings statement
Presentation
Analysis
Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation.
Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt.
Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets.
Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.
Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss:
difference between the actual return and the expected return on plan assets and,
amortization of the unrecognized net gain or loss from previous periods

4. The Corporate Form of Organization
An entity separate and distinct from its owners.
Classified by Purpose
Not-for-Profit
For Profit
Classified by Ownership
Publicly held
Privately held
Salvation Army
American Cancer Society
Gates Foundation
McDonald’s
Ford Motor Company
PepsiCo
Google
Cargill Inc.

5. Characteristics of a Corporation
Characteristics that distinguish corporations from proprietorships and partnerships.
Separate Legal Existence
Limited Liability of Stockholders
Transferable Ownership Rights
Ability to Acquire Capital
Continuous Life
Government Regulations
Additional Taxes
Corporate Management
Advantages
Disadvantages
SO 1 Identify the major characteristics of a corporation.

6. Characteristics of a Corporation
Stockholders
Illustration 12-1
Corporation organization chart
Chairman and
Board of
Directors
President and
Chief Executive
Officer
General
Counsel and
Secretary
Vice President
Marketing
Vice President
Finance/Chief
Financial Officer
Vice President
Operations
Vice President
Human
Resources
Treasurer
Controller
SO 1 Identify the major characteristics of a corporation.

7. Forming a Corporation Initial Steps:
File application with the Secretary of State.
State grants charter.
Corporation develops by-laws.
Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, New Jersey).
Corporations expense organization costs as incurred.
SO 1 Identify the major characteristics of a corporation.

8. Ownership Rights of Stockholders
Illustration 12-3
Stockholders have the right to:
1. Vote in election of board of directors and on actions that require stockholder approval.
2. Share the corporate earnings through receipt of dividends.
SO 1 Identify the major characteristics of a corporation.

9. Ownership Rights of Stockholders
Illustration 12-3
Stockholders have the right to:
3. Keep the same percentage ownership when new shares of stock are issued (preemptive right*).
* A number of companies have eliminated the preemptive right.
SO 1 Identify the major characteristics of a corporation.

10. Ownership Rights of Stockholders
Illustration 12-3
Stockholders have the right to:
4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim.
SO 1 Identify the major characteristics of a corporation.

11. Ownership Rights of Stockholders
Illustration 12-4
Prenumbered
Class
Class A COMMON STOCK
Class A COMMON STOCK
PAR VALUE $1 PER SHARE
PAR VALUE $1 PER SHARE
Name of corporation
Stockholder’s name
Shares
Stock Certificate
Signature of corporate official
SO 1 Identify the major characteristics of a corporation.

12. Stock Issue Considerations
Authorized Stock
Charter indicates the amount of stock that a corporation is authorized to sell.
Number of authorized shares is often reported in the stockholders’ equity section.
SO 1 Identify the major characteristics of a corporation.

13. Stock Issue Considerations
Issuance of Stock
Corporation can issue common stock
directly to investors or
indirectly through an investment banking firm.
Factors in setting price for a new issue of stock:
the company’s anticipated future earnings
its expected dividend rate per share
its current financial position
the current state of the economy
the current state of the securities market
SO 1 Identify the major characteristics of a corporation.

14. Stock Issue Considerations
Market Value of Stock
Stock of publicly held companies is traded on organized exchanges.
Interaction between buyers and sellers determines the prices per share.
Prices set by the marketplace tend to follow the trend of a company’s earnings and dividends.
Factors beyond a company’s control, may cause day-to-day fluctuations in market prices.
SO 1 Identify the major characteristics of a corporation.

15. Stock Issue Considerations
Par and No-Par Value Stock
Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors.
Today many states do not require a par value.
No-par value stock is quite common today.
In many states the board of directors assigns a stated value to no-par shares.
SO 1 Identify the major characteristics of a corporation.

16. Corporate Capital
Common Stock
Account
Paid-in Capital
Paid-in Capital in Excess of Par
Account
Preferred Stock
Account
Two Primary Sources of Equity
Retained Earnings
Account
Paid-in capital is the total amount of cash and other assets paid in by stockholders in exchange for capital stock.
SO 1 Identify the major characteristics of a corporation.

17. Corporate Capital
Common Stock
Account
Paid-in Capital
Paid-in Capital in Excess of Par
Account
Preferred Stock
Account
Two Primary Sources of Equity
Retained Earnings
Account
Retained earnings is net income that a corporation retains for future use.
SO 1 Identify the major characteristics of a corporation.

18. Corporate Capital
Comparison of the owners’ equity (stockholders’ equity) accounts reported on a balance sheet for a proprietorship and a corporation.
Illustration 12-6
SO 1 Identify the major characteristics of a corporation.

19. Accounting for Common Stock Issues
Issuing Par Value Common Stock for Cash
Primary objectives:
Identify specific sources of paid-in capital.
Maintain distinction between paid-in capital and retained earnings.
Issuing No-Par Common Stock for Cash
Avoids contingent liability for stockholders.
SO 2 Record the issuance of common stock.

20. Accounting for Common Stock Issues
Illustration: Viking Corporation issued 300 shares of $10 par value common stock for $4,100. Prepare Vikings’ journal entry.
Cash 4,100
Common stock (300 x $10) 3,000
Paid-in capital in excess of par 1,100
SO 2 Record the issuance of common stock.

21. Accounting for Common Stock Issues
Illustration: Knopfle Corporation issued 600 shares of no-par common stock for $10,200. Prepare Knopfle’s journal entry if (a) the stock has no stated value, and (b) the stock has a stated value of $2 per share. a.
Cash 10,200
Common stock ,200 b.
Cash 10,200
Common stock (600 x $2) 1,200
Paid-in capital in excess of stated value 9,000
SO 2 Record the issuance of common stock.

22. Accounting for Common Stock Issues
Issuing Common Stock for Services or
Noncash Assets
Corporations also may issue stock for:
Services (attorneys or consultants).
Noncash assets (land, buildings, and equipment).
Cost is either the fair market value of the consideration given up, or the fair market value of the consideration received, whichever is more clearly determinable.
SO 2 Record the issuance of common stock.

23. Accounting for Common Stock Issues
Illustration: On March 2nd, Leone Co. issued 5,000 shares of $5 par value common stock to attorneys in payment of a bill for $30,000 for services provided in helping the company to incorporate.
Organizational expense 30,000
Common stock (5,000 x $5) 25,000
Paid-in capital in excess of par 5,000
SO 2 Record the issuance of common stock.

24. Accounting for Common Stock Issues
Illustration: Kane Inc.’s $10 par value common stock is actively traded at a market value of $15 per share. Kane issues 5,000 shares to purchase land advertised for sale at $85,000. Journalize the issuance of the stock in acquiring the land.
Land (5,000 x $15) 75,000
Common stock (5,000 x $10) 50,000
Paid-in capital in excess of par 25,000
SO 2 Record the issuance of common stock.

25. Accounting for Treasury Stock
Common Stock
Account
Paid-in Capital
Paid-in Capital in Excess of Par
Account
Preferred Stock
Account
Two Primary Sources of Equity
Retained Earnings
Account
Less:
Treasury Stock
Account
SO 3 Explain the accounting for treasury stock.

26. Accounting for Treasury Stock
Treasury stock - corporation’s own stock that it has reacquired from shareholders, but not retired.
Corporations purchase their outstanding stock:
To reissue shares to officers and employees under bonus and stock compensation plans.
To enhance the stock’s market value.
To have additional shares available for use in acquisition of other companies.
To increase earnings per share.
To rid company of disgruntled investors, perhaps to avoid a takeover.
SO 3 Explain the accounting for treasury stock.

27. Accounting for Treasury Stock
Purchase of Treasury Stock
Two acceptable methods:
Cost method (more widely used).
Par or Stated value method.
Treasury stock, reduces stockholders’ equity.
SO 3 Explain the accounting for treasury stock.

28. Accounting for Treasury Stock
Illustration: UC Company originally issued 15,000 shares of $1 par, common stock for $25 per share. Record the journal entry for the following transaction:
April 1st the company re-acquired 1,000 shares for $28 per share.
Treasury stock (1,000 x $28) 28,000
Cash 28,000
SO 3 Explain the accounting for treasury stock.

29. Accounting for Treasury Stock
Stockholders’ Equity with Treasury stock
The number of shares issued (15,000), outstanding (14,000) and in the treasury (1,000) are disclosed. .
SO 3 Explain the accounting for treasury stock.

30. Accounting for Treasury Stock
Sale of Treasury Stock
Above Cost
Below Cost
Both increase total assets and stockholders’ equity.
SO 3 Explain the accounting for treasury stock.

31. Accounting for Treasury Stock
Above Cost
Accounting for Treasury Stock
Illustration: On April 1st, UC Company reacquired 1,000 shares of its $1 par, common stock, for $28 per share.
June 1st Sold 500 shares of its Treasury Stock for $30 per share.
Cash (500 x $30) 15,000
Treasury stock (500 x $28) 14,000
Paid-in capital treasury stock 1,000
SO 3 Explain the accounting for treasury stock.

32. Accounting for Treasury Stock
Below Cost
Accounting for Treasury Stock
Illustration: Record the journal entry for the following transaction:
Oct. 15th Sold 300 shares of its Treasury Stock for $9 per share.
Cash (300 x $9) 2,700
Limited to balance on hand
Paid-in capital treasury stock 1,000
Retained earnings 4,700
Treasury stock (300 x $28) 8,400
SO 3 Explain the accounting for treasury stock.

33. Accounting for Treasury Stock
Below Cost
Accounting for Treasury Stock
Illustration: Record the journal entry for the following transaction:
Oct. 30th Sold 100 shares of its Treasury Stock for $11 per share.
Cash (100 x $11) 1,100
Retained earnings 1,700
Treasury stock (100 x $28) 2,800
SO 3 Explain the accounting for treasury stock.

34. Accounting for Treasury Stock
Stockholders’ Equity with Treasury stock
The number of shares issued (15,000), outstanding (14,900) and in the treasury (100) are disclosed .
SO 3 Explain the accounting for treasury stock.

35. Preferred Stock Features often associated with preferred stock.
Preference as to dividends.
Preference as to assets in liquidation.
Nonvoting.
Accounting for preferred stock at issuance is similar to that for common stock.
SO 4 Differentiate preferred stock from common stock.

36. Preferred Stock
Illustration: Acker Inc. issues 5,000 shares of $100 par value preferred stock for cash at $130 per share. Journalize the issuance of the preferred stock.
Cash (5,000 x $130) 650,000
Preferred stock (5,000 x $100) ,000
Paid-in capital in excess of par –
Preferred stock 150,000
Preferred stock may have a par value or no-par value.
SO 4 Differentiate preferred stock from common stock.

37. Preferred Stock Dividend Preferences
Right to receive dividends before common stockholders.
Per share dividend amount is stated as a percentage of preferred stock’s par value or as a specified amount.
Cumulative dividend – preferred stockholders must be paid both current-year dividends and any unpaid prior-year (arrears) dividends before common stockholders receive dividends.
SO 4 Differentiate preferred stock from common stock.

38. Dividends
A distribution of cash or stock to stockholders on a pro rata (proportional) basis.
Types of Dividends:
Cash dividends.
Property dividends.
Script (promissory note).
Stock dividends.
Dividends expressed: (1) as a percentage of the par or stated value, or (2) as a dollar amount per share.
SO 5 Prepare the entries for cash dividends and stock dividends.

39. Dividends Dividends require information concerning three dates:
SO 5 Prepare the entries for cash dividends and stock dividends.

40. Dividends Cash Dividends
For a corporation to pay a cash dividend, it must have:
Retained earnings - Payment of cash dividends from retained earnings is legal in all states.
Adequate cash.
A declaration of dividends by the Board of Directors.
SO 5 Prepare the entries for cash dividends and stock dividends.

41. Dividends
Illustration: What would be the journal entries made by a corporation that declared a $50,000 cash dividend on March 10, payable on April 6 to shareholders of record on March 25?
March 10 (Declaration Date)
Retained earnings 50,000
Dividends payable 50,000
March 25 (Date of Record) No entry
April 6 (Payment Date)
Dividends payable 50,000
Cash 50,000
SO 5 Prepare the entries for cash dividends and stock dividends.

42. Allocating Cash Dividends Between Preferred and Common Stock
Holders of cumulative preferred stock must be paid any unpaid prior-year dividends before common stockholders receive dividends.
SO 5 Prepare the entries for cash dividends and stock dividends.

43. Dividends
Exercise: Arnez Corporation was organized on January 1, During its first year, the corporation issued 2,000 shares of $50 par value preferred stock and 100,000 shares of $10 par value common stock. At December 31, the company declared the following cash dividends: 2007, $6,000, 2008, $12,000, and 2009, $28,000.
Instructions: (a) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 8% and not cumulative.
SO 5 Prepare the entries for cash dividends and stock dividends.

44. Dividends
Exercise: (a) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 8% and not cumulative. *
* 2,000 shares x $50 par x 8% = $8,000
SO 5 Prepare the entries for cash dividends and stock dividends.

45. Dividends
Exercise: (b) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 9% and cumulative. ** *
* 2,000 shares x $50 par x 9% = $9,000
** 2007 Pfd. dividends $9,000 – declared $6,000 = $3,000
SO 5 Prepare the entries for cash dividends and stock dividends.

46. Dividends
Exercise: (c) Journalize the declaration of the cash dividend at December 31, 2009, under part (b).
Journal entry:
Retained earnings 28,000
Dividends payable 28,000
SO 5 Prepare the entries for cash dividends and stock dividends.

47. Stock Dividends Stock Dividends
Pro rata distribution of the corporation’s own stock.
Illustration 12-14
Results in decrease in retained earnings and increase in paid-in capital.
SO 5 Prepare the entries for cash dividends and stock dividends.

48. Stock Dividends Stock Dividends
Reasons why corporations issue stock dividends:
Satisfy stockholders’ dividend expectations without spending cash.
Increase marketability of corporation’s stock.
Emphasize that a portion of stockholders’ equity has been permanently reinvested in the business.
SO 5 Prepare the entries for cash dividends and stock dividends.

49. Stock Dividends Size of Stock Dividends
Small stock dividend (less than 20–25% of the corporation’s issued stock, recorded at fair market value)
Large stock dividend (greater than 20–25% of issued stock, recorded at par value) *
* Assumption that a small stock dividend will have little effect on market price of outstanding shares.
SO 5 Prepare the entries for cash dividends and stock dividends.

50. Stock Dividends
Illustration: HH Inc. has 5,000 shares issued and outstanding. The per share par value is $1, book value $32 and market value is $40.
10% stock dividend is declared
Retained earnings (5,000 x 10% x $40)
20,000
Common stock dividends distributable
500
Additional paid-in capital
19,500
Stock issued
Common stock div. distributable
500
Common stock (5,000 x 10% x $1)
500
SO 5 Prepare the entries for cash dividends and stock dividends.

51. Stock Dividends Stockholders’ Equity with Dividends Distributable
SO 5 Prepare the entries for cash dividends and stock dividends.

52. Stock Dividends Effects of Stock Dividends $ 0$
SO 5 Prepare the entries for cash dividends and stock dividends.

53. Stock Split Stock Split Reduces the market value of shares.
No entry recorded for a stock split.
Decrease par value and increase number of shares.
SO 5 Prepare the entries for cash dividends and stock dividends.

54. Stock Split
Illustration: HH Inc. has 5,000 shares issued and outstanding. The per share par value is $1, book value $32 and market value is $40.
2 for 1 Stock Split
No Entry -- Disclosure that par is now $.50 and shares outstanding are 10,000.
SO 5 Prepare the entries for cash dividends and stock dividends.

55. Stock Split Effects of Stock Split
SO 5 Prepare the entries for cash dividends and stock dividends.

56. Retained Earnings
Retained earnings is net income that a company retains for use in the business.
Net income increases Retained Earnings and a net loss decreases Retained Earnings.
Retained earnings is part of stockholders’ claim on total assets of the corporation.
Debit balance in Retained Earnings is identified as a deficit.
SO 6 Identify the items reported in a retained earnings statement.

57. Retained Earnings Restrictions
Restrictions can result from:
Legal restrictions.
Contractual restrictions.
Voluntary restrictions.
Companies generally disclose retained earnings restrictions in the notes to the financial statements.
SO 6 Identify the items reported in a retained earnings statement.

58. Prior Period Adjustments
Corrections of Errors
Result from:
mathematical mistakes
mistakes in application of accounting principles
oversight or misuse of facts
Corrections treated as prior period adjustments
Adjustment to beginning balance of retained earnings
SO 6 Identify the items reported in a retained earnings statement.

59. Prior Period Adjustments
Before issuing the report for the year ended December 31, 2007, you discover a $50,000 error (net of tax) that caused 2006 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2006). Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2007?
SO 6 Identify the items reported in a retained earnings statement.

60. Retained Earnings Statement
SO 6 Identify the items reported in a retained earnings statement.

61. Retained Earnings Statement
The company prepares the statement from the Retained Earnings account.
Illustration 12-24
SO 6 Identify the items reported in a retained earnings statement.

62. Statement Analysis and Presentation
Illustration 12-26
SO 7 Prepare and analyze a comprehensive stockholders’ equity section.

63. Return on Common Stockholders’ Equity
Statement Analysis and Presentation
Stockholders’ Equity Analysis
Net Income Available to Common Stockholders
Return on Common Stockholders’ Equity =
Average Common Stockholders’ Equity
Ratio shows how many dollars of net income the company earned for each dollar invested by the stockholders.
SO 7 Prepare and analyze a comprehensive stockholders’ equity section.

64. All About You Home-Equity Loans
Many have chosen to use home-equity loans to finance vacations, new cars, home improvements, educational pursuits, and consolidate debt, thus reducing the equity in that home.
Some Facts:
PNC Financial Services Group Inc. offered gifts, two airline tickets, to borrowers who took out a new home-equity loan.
Many banks are extending the length of home-equity loans.

65. All About You Home-Equity Loans Some Facts:
While home-equity loans tend to have fixed rates, home-equity lines of credit, have variable rates.
Home-equity loan interest is tax deductible (like home mortgage interest). Interest on car loans, most student loans, and credit cards is not.

66. All About You
Suppose that you wanted to borrow $5,000 to take a vacation. You could spread your payments over 15 years and pay only about $50 per month. But look what your total payments would be over the life of the 15-year loan. Some vacation!
Source: Data from, “When Mining Your Home for Money, Beware of Fool’s Gold,” Good Advice Press, (accessed June 20, 2006).

67. All About You What Do You Think?
Your home has increased in value by $50,000 during the last five years. You have very little savings outside of the equity in your home. You desperately need a vacation, and you are considering taking out a $5,000 home-equity loan to finance a two-week dream vacation in Europe. Is this is a bad idea?
YES: This represents a significant portion of your savings. Home-equity loans should be used to finance investments of a lasting nature, not items of a
fleeting nature like vacations.
NO: If you use equity in your home now, you can make it up when your house increases in value in the future.

68. Copyright
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