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13-1 Prepared by Coby Harmon University of California, Santa Barbara Westmont College.

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1 13-1 Prepared by Coby Harmon University of California, Santa Barbara Westmont College

2 13-2 Learning Objectives After studying this chapter, you should be able to: [1] Identify the major characteristics of a corporation. [2] Differentiate between paid-in capital and retained earnings. [3] Record the issuance of common stock. [4] Explain the accounting for treasury stock. [5] Differentiate preferred stock from common stock. [6] Prepare a stockholders’ equity section. 13 Corporations: Organization and Capital Stock Transactions

3 13-3 Preview of Chapter 13 Accounting Principles Eleventh Edition Weygandt Kimmel Kieso

4 13-4 An entity separate and distinct from its owners. Classified by Purpose  Not-for-Profit  For Profit Classified by Ownership  Publicly held  Privately held ► McDonald’s ► Nike ► PepsiCo ► Google ► Salvation Army ► American Cancer Society ► Cargill Inc. The Corporate Form of Organization LO 1 Identify the major characteristics of a corporation. Alternative Terminology Privately held corporations are also referred to as closely held corporations. Alternative Terminology Privately held corporations are also referred to as closely held corporations.

5 13-5 Characteristics that distinguish corporations from proprietorships and partnerships. LO 1 Identify the major characteristics of a corporation. Advantages Disadvantages Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

6 13-6 LO 1 Identify the major characteristics of a corporation. Corporation acts under its own name rather than in the name of its stockholders. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

7 13-7 LO 1 Identify the major characteristics of a corporation. Limited to their investment. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

8 13-8 LO 1 Identify the major characteristics of a corporation. Shareholders may sell their stock. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

9 13-9 LO 1 Identify the major characteristics of a corporation. Corporation can obtain capital through the issuance of stock. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

10 13-10 LO 1 Identify the major characteristics of a corporation. Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

11 13-11 Separation of ownership and management prevents owners from having an active role in managing the company. LO 1 Identify the major characteristics of a corporation. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes

12 13-12  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes LO 1 Identify the major characteristics of a corporation. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization

13 13-13 LO 1 Identify the major characteristics of a corporation. Characteristics that distinguish corporations from proprietorships and partnerships. Characteristics of an Organization  Separate Legal Existence  Limited Liability of Stockholders  Transferable Ownership Rights  Ability to Acquire Capital  Continuous Life  Corporate Management  Government Regulations  Additional Taxes Corporations pay income taxes as a separate legal entity and in addition, stockholders pay taxes on cash dividends.

14 13-14 Stockholders Chairman and Board of Directors President and Chief Executive Officer General Counsel/ Secretary Vice President Marketing Vice President Finance/Chief Financial Officer Vice President Operations Vice President Human Resources TreasurerController Illustration 13-1 Corporation organization chart Characteristics of an Organization LO 1 Identify the major characteristics of a corporation.

15 13-15 Forming a Corporation  File application with the Secretary of State.  State grants charter.  Corporation develops by-laws. Initial Steps: Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, New Jersey). Corporations engaged in interstate commerce must obtain a license from each state in which they do business. The Corporate Form of Organization LO 1 Identify the major characteristics of a corporation. Alternative Terminology The charter is often referred to as the articles of incorporation. Alternative Terminology The charter is often referred to as the articles of incorporation.

16 Vote in election of board of directors and on actions that require stockholder approval. Stockholders Rights 2.Share the corporate earnings through receipt of dividends. Illustration 11-3 The Corporate Form of Organization LO 1 Identify the major characteristics of a corporation.

17 Keep the same percentage ownership when new shares of stock are issued (preemptive right, which is a principle established in company law, according to which any new shares issued by a company must first be offered to the existing shareholders as the legitimate owners of the company). Stockholders Rights Illustration 11-3 The Corporate Form of Organization * A number of companies have eliminated the preemptive right. LO 1 Identify the major characteristics of a corporation.

18 Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. Stockholders Rights Illustration 11-3 The Corporate Form of Organization LO 1 Identify the major characteristics of a corporation.

19 13-19

20 13-20  Charter indicates the amount of stock that a corporation is authorized to sell. If a company sells all authorized stock, it must obtain consent of the state to amend its charter before it can issue additional shares.  Number of authorized shares is often reported in the stockholders’ equity section, but a formal accounting entry is not needed since this event has no immediate effect on either corporate assets or stockholders’ equity. Authorized Stock Stock Issue Considerations LO 1 Identify the major characteristics of a corporation.

21 13-21 Name of corporation Stockholder’s name Shares Signature of corporate official Prenumbered Illustration 13-4 Stock Issue Considerations LO 1

22 13-22 LO 1 Identify the major characteristics of a corporation.  Corporation can issue common stock directly to investors or indirectly through an investment banking firm that specializes in bringing securities to the attention of prospective investors. The investment banking firm might agree to underwrite the entire stock issue. This means that these banking firms buys the stock from the corporation at a stipulated price and resell them to investors. The corporation thus avoid any risk of being unable to sell the shares. Also, it obtains immediate use of the cash received from the underwriters.  Factors in setting price for a new issue of stock: 1.Company’s anticipated future earnings. 2.Expected dividend rate per share. 3.Current financial position. 4.Current state of the economy. 5.Current state of the securities market. Issuance of Stock Stock Issue Considerations

23 13-23 LO 1 Identify the major characteristics of a corporation.  Stock of publicly held companies is traded on organized exchanges.  Interaction between buyers and sellers determines the prices per share.  Prices 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. Examples on these factors are; oil embargo, changes in interest rates, the outcome of a presidential election, etc. Market Price of Stock Stock Issue Considerations

24 13-24

25 13-25  Par value stock is capital stock to which the charter has assigned a value per share.  Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors. Thus, corporations were required to sell their shares at par or above.  Legal capital is the amount of stockholders’ equity, which cannot be reduced by the payment of dividends and not available for withdrawals by stockholders.  Today many states do not require a par value. This due to the fact that par value was often immaterial relative to the value of the company’s stock, even at the time of issue.  No-par value stock is capital stock to which the charter has not assigned a value, and it is quite common today.  In many states the board of directors assigns a stated value to no-par shares. Par and No-Par Value Stock Stock Issue Considerations LO 1 Identify the major characteristics of a corporation.

26 13-26 Question Which of these statements is false? a.Ownership of common stock gives the owner a voting right. b.The stockholders’ equity section begins with paid-in capital. c.The authorization of capital stock does not result in a formal accounting entry. d.Legal capital is intended to protect stockholders. Stock Issue Considerations LO 1 Identify the major characteristics of a corporation.

27 13-27 Indicate whether each of the following statements is true or false. ______ 1. Similar to partners in a partnership, stockholders of a corporation have unlimited liability. ______ 2. It is relatively easy for a corporation to obtain capital through the issuance of stock. ______ 3. The separation of ownership and management is an advantage of the corporate form of business. ______ 4. The journal entry to record the authorization of capital stock includes a credit to the appropriate capital stock account. ______ 5. All states require a par value per share for capital stock. False True False DO IT! > LO 1 Identify the major characteristics of a corporation.

28 13-28 Paid-in Capital Retained Earnings Account Account Paid-in Capital in Excess of Par Account Account Two Primary Sources of Equity Common Stock Account Account Preferred Stock Account Account LO 2 Differentiate between paid-in capital and retained earnings. Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock. Corporate Capital

29 13-29 Paid-in Capital Retained Earnings Account Account Two Primary Sources of Equity Common Stock Account Account Preferred Stock Account Account LO 2 Differentiate between paid-in capital and retained earnings. Retained earnings is net income that a corporation retains for future use. Corporate Capital Paid-in Capital in Excess of Par Account Account

30 13-30 LO 2 Differentiate between paid-in capital and retained earnings. Comparison of the owners’ equity (stockholders’ equity) accounts reported on a balance sheet for a proprietorship, a partnership, and a corporation. Illustration 13-6 Corporate Capital

31 13-31

32 13-32 The primary objectives in accounting for the issuance of common stock are: 1)To identify the specific sources of paid-in capital, and 2)To maintain the distinction between paid-in capital and retained earnings. LO 3 Record the issuance of common stock. Other than consideration received, the issuance of common stock affects only paid-in capital accounts. Accounting for Common Stock Issues

33 13-33 Illustration: Assume that Hydro-Slide, Inc. issues (a)1,000 shares of $1 par value common stock, and (b) 1,000 shares for $5 per share. Prepare Hydro-Slide’s journal entry to record the issuance of these 2,000 shares. Cash1,000 Common Stock (1,000 x $1) 1,000 Cash5,000 Common Stock (1,000 x $1) 1,000 Paid-in Capital in Excess of Par Value 4,000 a. b. LO 3 Record the issuance of common stock. Issuing Par Value Common Stock for Cash Accounting for Common Stock Issues

34 13-34 LO 3 Record the issuance of common stock. Illustration 13-7 Accounting for Common Stock Issues Alternative Terminology Paid-in Capital in Excess of Par is also called Premium on Stock. Alternative Terminology Paid-in Capital in Excess of Par is also called Premium on Stock.

35 13-35 Accounting for Common Stock Issues Issuing no-Par Common Stock for Cash Assume that instead of $1 par value stock, Hydro-Slide, Inc. has $5 stated value no-par stock and the company issues 5,000 shares at $8 per share for cash. Prepare the journal entry to record the issuance of these shares. Assume that instead of $1 par value stock, Hydro-Slide, Inc. has $5 stated value no-par stock and the company issues 5,000 shares at $8 per share for cash. Prepare the journal entry to record the issuance of these shares. Cash 40,000 Cash 40,000 Common Stock 25,000 Common Stock 25,000 Paid-in Capital in Excess of Stated Value 15,000 Paid-in Capital in Excess of Stated Value 15,000

36 13-36 Issuing Common Stock for Services or Noncash Assets Corporations also may issue stock for:  Services (attorneys or consultants).  Noncash assets (land, buildings, and equipment). LO 3 Record the issuance of common stock. 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. Accounting for Common Stock Issues

37 13-37 Illustration: Attorneys have helped Jordan Company incorporate. They have billed the company $5,000 for their services. They agree to accept 4,000 shares of $1 par value common stock in payment of their bill. At the time of the exchange, there is no established market price for the stock. Prepare the journal entry for this transaction. Organizational Expense5,000 Common Stock (4,000 x $1) 4,000 Paid-in Capital in Excess of par1,000 LO 3 Record the issuance of common stock. Accounting for Common Stock Issues

38 13-38 Illustration: Athletic Research Inc. is an existing publicly held corporation. Its $5 par value stock is actively traded at $8 per share. The company issues 10,000 shares of stock to acquire land recently advertised for sale at $90,000. Prepare the journal entry for this transaction. Land (10,000 x $8)80,000 Common Stock (10,000 x $5) 50,000 Paid-in Capital in Excess of Par30,000 LO 3 Record the issuance of common stock. Accounting for Common Stock Issues

39 13-39 THE MISSING CONTROLS Independent internal verification. The company’s board of directors should have ensured that the awards were properly administered. For example, the date on the minutes from the board meeting could be compared to the dates that were recorded for the awards. In addition, the dates should again be confirmed upon exercise. Total take: $7 billion ANATOMY OF A FRAUD The president, chief operating officer, and chief financial officer of SafeNet, a software encryption company, were each awarded employee stock options by the company’s board of directors as part of their compensation package. Stock options enable an employee to buy a company’s stock sometime in the future at the price that existed when the stock option was awarded. For example, suppose that you received stock options today, when the stock price of your company was $30. Three years later, if the stock price rose to $100, you could “exercise” your options and buy the stock for $30 per share, thereby making $70 per share. After being awarded their stock options, the three employees changed the award dates in the company’s records to dates in the past, when the company’s stock was trading at historical lows. For example, using the previous example, they would choose a past date when the stock was selling for $10 per share, rather than the $30 price on the actual award date. In our example, this would increase the profit from exercising the options to $90 per share. Advance slide in presentation mode to reveal answer.

40 13-40 Paid-in Capital Retained Earnings Account Account Paid-in Capital in Excess of Par Account Account Less: Treasury Stock AccountLess: Treasury Stock Account Two Primary Sources of Equity Common Stock Account Account Preferred Stock Account Account LO 4 Explain the accounting for treasury stock. Accounting for Treasury Stock

41 13-41 Treasury stock - corporation’s own stock that it has reacquired from shareholders, but not retired. Corporations purchase their outstanding stock: 1.To reissue the shares to officers and employees under bonus and stock compensation plans. 2.To enhance the stock’s market value. 3.To have additional shares available for use in the acquisition of other companies. 4.To increase earnings per share. LO 4 Explain the accounting for treasury stock. Accounting for Treasury Stock

42 13-42 Purchase of Treasury Stock  Debit Treasury Stock for the price paid to reacquire the shares.  Treasury stock is a contra stockholders’ equity account, not an asset.  Purchase of treasury stock reduces stockholders’ equity. LO 4 Explain the accounting for treasury stock. Accounting for Treasury Stock Helpful Hint Treasury shares do not have dividend rights or voting rights. Helpful Hint Treasury shares do not have dividend rights or voting rights.

43 13-43 Treasury Stock (4,000 x $8) 32,000 Cash 32,000 Illustration: On February 1, 2014, Mead acquires 4,000 shares of its stock at $8 per share. LO 4 Explain the accounting for treasury stock. Illustration 13-8 Accounting for Treasury Stock

44 13-44 LO 4 Explain the accounting for treasury stock. Both the number of shares issued (100,000), outstanding (96,000), and the number of shares held as treasury (4,000) are disclosed. Accounting for Treasury Stock Illustration 13-9 Stockholders’ equity with treasury stock

45 13-45

46 13-46 Sale of Treasury Stock  Above Cost  Below Cost Both increase total assets and stockholders’ equity. LO 4 Explain the accounting for treasury stock. Accounting for Treasury Stock Disposal of Treasury Stock Helpful Hint Treasury stock transactions are classified as capital stock transactions. As in the case when stock is issued, the income statement is not involved. Helpful Hint Treasury stock transactions are classified as capital stock transactions. As in the case when stock is issued, the income statement is not involved.

47 13-47 Treasury Stock 8,000 Illustration: On July 1, Mead sells for $10 per share 1,000 shares of its treasury stock, previously acquired at $8 per share. LO 4 Explain the accounting for treasury stock. July 1 Paid-in Capital Treasury Stock 2,000 Cash 10,000 A corporation does not realize a gain or suffer a loss from stock transactions with its own stockholders. Accounting for Treasury Stock Above Cost

48 13-48 Paid-in Capital Treasury Stock 800 Illustration: On Oct. 1, Mead sells an additional 800 shares of treasury stock at $7 per share. LO 4 Explain the accounting for treasury stock. Oct. 1 Treasury Stock 6,400 Cash 5,600 Accounting for Treasury Stock Below Cost Illustration 13-10

49 13-49 Paid-in Capital Treasury Stock 1,200 Illustration: On Dec. 1, assume that Mead, Inc. sells its remaining 2,200 shares at $7 per share. LO 4 Explain the accounting for treasury stock. Dec. 1 Retained Earnings 1,000 Cash 15,400 Treasury Stock 17,600 Limited to balance on hand Accounting for Treasury Stock Below Cost

50 13-50 Features often associated with preferred stock. 1. Preference as to dividends. 2. Preference as to assets in liquidation. 3. Nonvoting. LO 5 Differentiate preferred stock from common stock. Accounting for preferred stock at issuance is similar to that for common stock. Preferred Stock

51 13-51 Illustration: Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. Journalize the issuance of the preferred stock. LO 5 Differentiate preferred stock from common stock. Cash120,000 Preferred Stock (10,000 x $10) 100,000 Paid-in Capital in Excess of Par – Preferred Stock20,000 Preferred stock may have a par value or no-par value. Preferred Stock

52 13-52   Right to receive dividends before common stockholders.   Per share dividend amount is stated as a percentage of the preferred stock’s par value or as a specified amount.   Cumulative dividend – holders of preferred stock must be paid their annual dividend plus any dividends in arrears before common stockholders receive dividends. LO 5 Differentiate preferred stock from common stock. Preferred Stock Dividend Preferences

53 13-53 LO 5 Differentiate preferred stock from common stock. Preferred Stock Cumulative Dividend Illustration: Scientific Leasing has 5,000 shares of 7%, $100 par value, cumulative preferred stock outstanding. Each $100 share pays a $7 dividend (.07 x $100). The annual dividend is $35,000 (5,000 x $7 per share). If dividends are two years in arrears, preferred stockholders are entitled to receive the following dividends in the current year. Illustration 13-11

54 13-54   Most preferred stocks have a preference on corporate assets if the corporation fails.   Provides security for the preferred stockholder.   Preference to assets may be for the par value of the shares or for a specified liquidating value. LO 5 Differentiate preferred stock from common stock. Preferred Stock Liquidation Preferences

55 13-55 LO 6 Prepare a stockholders’ equity section. Illustration Statement Presentation

56 13-56 Key Points A Look at IFRS LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.  Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences.  Many countries have a different mix of investor groups than in the United States. For example, in Germany, financial institutions like banks are not only major creditors of corporations but often are the largest corporate stockholders as well. In the United States, Asia, and the United Kingdom, many companies rely on substantial investment from private investors.

57 13-57 Key Points A Look at IFRS LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.  There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology.

58 13-58 Key Points A Look at IFRS LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.  The accounting for treasury stock differs somewhat between IFRS and GAAP. (However, many of the differences are beyond the scope of this course.) Like GAAP, IFRS does not allow a company to record gains or losses on purchases of its own shares. One difference worth noting is that, when a company purchases its own shares, IFRS treats it as a reduction of stockholders’ equity, but it does not specify which particular stockholders’ equity accounts are to be affected. Therefore, it could be shown as an increase to a contra equity account (Treasury Stock) or a decrease to retained earnings or share capital.

59 13-59 Key Points A Look at IFRS LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.  A major difference between IFRS and GAAP relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant, and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital.  IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.  Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and shareholders’ funds.

60 13-60 Looking to the Future A Look at IFRS LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS. As indicated in earlier discussions, the IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements.

61 13-61 Under IFRS, a purchase by a company of its own shares is recorded by: a)an increase in Treasury Stock. b)a decrease in contributed capital. c)a decrease in share capital. d)All of these are acceptable treatments A Look at IFRS IFRS Self-Test Questions LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

62 13-62 A Look at IFRS IFRS Self-Test Questions Which of the following is true? a)In the United States, the primary corporate stockholders are financial institutions. b)Share capital means total assets under IFRS. c)The IASB and FASB are presently studying how financial statement information should be presented. d)The amount to treasury stock is very different between U.S. GAAP and IFRS. LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

63 13-63 A Look at IFRS IFRS Self-Test Questions Under IFRS, the amount of capital received in excess of par value would be credited to: a)Retained Earnings. b)Contributed Capital. c)Share Premium. d)Par value is not used under IFRS. LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

64 13-64 “Copyright © 2013 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” Copyright


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