CORPORATIONS: ORGANIZATION AND CAPITAL STOCK Sania Wadud Chapter 13 1

Learning Objective 1 Defining a corporation; establishing a corporation; listing the advantages and disadvantages of a corporation LO-1 2

Corporation  Business organization that is both a legal and accounting entity  Incorporators - those wishing to form the corporation  Submit articles of incorporation to the state when applying for charter LO-1 3

Articles of Incorporation  Name of corporation/incorporation date  Purpose of business  Organizational structure  Expected life (usually forever)  Primary business location  Types of stocks to be offered LO-1 4

Forming a Corporation Four steps: 1.Apply to a state for a charter. 2.Office of the Secretary of State reviews and issues charter to incorporators. 3.Stock is issued by corporation to owners (stockholders). 4.Stockholders meet to elect board of directors and adopt bylaws. LO-1 5

Advantages of Corporate Structure 1.Limited liability/Separate legal entity - not personally liable for corporate obligations 2.Unlimited life - goes on forever 3.Ease of transferring ownership interest - ownership is transferred through shares of stock 4.No mutual agency - actions of one stockholder are not binding to the corporation 5.Ease of raising capital - can raise large amounts of capital by assembling investment groups of stockholders LO-1 6

Disadvantages of Corporate Structure 1.Difficulties in forming a corporation: -More difficult to form than sole proprietorship/partnership -Government regulations - file many governmental reports -Have to hire lawyer due to legal aspects 2.Corporate Taxation: -May be t axed at state and local levels -Double taxation - earnings of the corporation are taxed at the corporate level as well as the personal level LO-1 7

Learning Objective 2 Journalizing entries for issuing par-value stock, no- par stock, and no-par with stated value stock LO-2 8

Stockholders’ Equity Two sections:  Paid-in capital – represents what stockholders have invested into the corporation  Retained earnings – accumulated profits of corporation that have been kept in the business LO-2 9

Capital Stock  Classes of stock that represent the fractional elements of ownership of a corporation  2 Classes:  Common Stock —the basic ownership of stock with rights to vote in election of directors, share in distribution of earnings, and purchase additional shares.  Preferred Stock —A class of stock with preferential rights over common stock in payment of dividends and company liquidation LO-2 10

Capital Stock  Authorized capital stock – number of shares listed in charter  Issued capital stock – shares sold to stockholders  Outstanding capital stock – shares sold and in stockholders’ possession LO-2 11

Authorized IssuedIssued Outstanding Number of Shares Sources of Paid-In Capital 12

Characteristics of Common Stock Basic ownership equity – rights 1. Right to vote at stockholders’ meetings 2. Right to share in profits by receiving dividends 3. Right to dispose of or sell their stock 4. Right to maintain their proportionate ownership interest (preemptive right) 5. Right, upon liquidation of company, to share in assets LO-2 13

Characteristics of Preferred Stock  Has preference to corporation’s profits and assets over Common Stock holders  Often give up some of the rights in return for more stable earnings - voting, preemptive, earnings potential  Less risky investment than Common Stock LO-2 14

Dividends on Common and Preferred Stock  Cash or other assets or shares of stock that a corporation issues to the stockholders  Must be voted by the board of directors  Bad years may not allow a dividend  May vote against a dividend even in good year LO-2 15

Features of Preferred Stock Cumulative - holders have a right to certain dividends each year; dividend will accumulate if not paid Noncumulative - holders have a right to current year’s dividend; does not accumulate Nonparticipating - holders receive a certain percentage as dividend; remainder goes to Common Stock Participating - holders get yearly dividend and can get a percentage of what’s left over. LO-2 16

Stock Value Par value ◦ Arbitrary value placed on each share of stock ◦ Represents minimum legal capital – amount a corporation must retain in the business for protection of creditors ◦ Stated on stock certificate No-par stock ◦ Stock with no par value ◦ Entire proceeds from selling represents the legal capital LO-2 17

Stock Value  Stated value  Most states permit or require that directors set a stated value  Arbitrary; can be changed by board of directors  Value is not printed on stock certificates  Directors can change without state approval  Does not mean market value LO-2 18

Recording Capital Stock Transactions New stockholders’ equity accounts  Common Stock  Preferred Stock  Paid-in Capital in Excess of Par Value - difference between what stockholders invest and par value.  Paid-in Capital in Excess of Stated Value - difference between what stockholders invest and stated value placed on stock by board of directors  Retained Earnings LO-2 19

Recording Capital Stock Transactions A corporation is authorized to issue 10,000 shares of preferred stock, $100 par, and 100,000 shares of common stock, $20 par. LO-2 On April 1, one-half of each class of authorized stock is issued at par for cash 20

Apr.1Cash1, Issued preferred stock and common stock at par. Preferred Stock Common Stock1,  Issuing Stock: A corporation is authorized to issue 10,000 shares of preferred stock, $100 par, and 100,000 shares of common stock, $20 par.  On April 1, one-half of each class of authorized stock is issued at par for cash. Recording Capital Stock Transactions

On March 15, Caldwell Company issues 2,000 shares of $50 par preferred stock for cash at $55. Mar.15Cash Issued 2,000 shares of $50 par preferred stock at $55. Preferred Stock Paid-in Capital in Excess of Par-- Preferred Stock Issuing Stock at a Premium

When stock is issued for more than its par, the stock has sold at a premium. It has sold at a discount if issued for less than its par. The $10,000 excess is recorded in a separate account because some states do not consider this to be part of legal capital and may be used for dividends. Issuing Stock at a Premium

On Nov. 12, a corporation acquired land for which the fair market value cannot be determined. The corporation issued 10,000 shares of $10 par common that has a current market value of $12 in exchange for the land. Nov.12Land Issued $10 par common stock valued at $12 per share, for land. Common Stock Paid-in Capital in Excess of Par Issuing Stock at a Premium

Stock issued for assets other than cash should be recorded at the fair market value of the asset or fair market value of the stock, whichever can be more clearly determined. Issuing Stock at a Premium

On March 15, Caldwell Company issues 2,000 shares of $50 par Common Stock stock for cash at $45. Mar.15Cash Discount on Common Stock Issued 2,000 shares of $50 par common stock at $45. Common Stock Issuing Stock at a Discount

On February 23, a corporation issues 10,000 shares of no-par common stock at $40 a share. Feb.23Cash Issued 10,000 shares of no-par common stock at $40. Common Stock Issuing Stock at No-par

Later, on March 9, the corporation issues 1,000 additional shares at $36. Mar.9Cash Issued 1,000 shares of no-par common stock at $36. Common Stock Issuing Stock at No-Par

Some states require that the entire proceeds from the sale of no-par stock be treated as legal capital. Also, no-par stock may be assigned a stated value per share. The stated value is recorded similar to a par value. Issuing Stock at No-Par

On March 30, issued 1,000 shares of no-par common stock at $40; stated value, $25. Mar.30Cash Issued 1,000 shares of no-par common stock at $40; stated value, $25. Common Stock Paid-in Capital in Excess of Stated Value Issuing Stock at Stated Value

Treasury stock is stock that: 1. has been issued as fully paid. 2.has been reacquired by the corporation. 3.has not been canceled or reissued A commonly used method of accounting for treasury stock is the cost method.. Occasionally, a corporation buys back its own stock for the purpose of later reissuing it. This stock is referred to as treasury stock. Treasury Stock Transaction

Cost Method On January 5, a firm purchased 1,000 shares of treasury stock (common stock, $25 par) at $45 per share. Jan.5Treasury Stock Purchased 1,000 shares of treasury stock at $45. Cash Treasury Stock Transaction

On June 2, sold 200 shares of treasury stock at $60 per share. June 2Cash Sold 200 shares of treasury stock at $60. Treasury Stock Paid-in Capital from sale of Treasury Stock Cost Method Treasury Stock Transaction

On September 3, sold 200 shares of treasury stock at $40 per share. Sep.3Cash Paid-in Capital from Sale of Treasury Stock Sold 200 shares of treasury stock at $40. Treasury Stock Cost Method Treasury Stock Transaction

Calculating Dividends Step 1: Calculate preferred dividend. Step 2: Calculate common dividend. Step 3: If preferred is fully participating, find total par value. Step 4: Allocate remainder of the dividend to preferred and common based on percentage of total par. LO-3 35

 Dividends are distributions of retained earnings to stockholders.  Dividends may be paid in cash, stock, or property.  Dividends, even on cumulative preferred stock, are never required, but once declared become a legal liability of the corporation. Accounting for Cash Dividend

Corporations generally declare and pay cash dividends on shares outstanding when three conditions exist: 1. Sufficient retained earnings 2. Sufficient cash 3. Formal action by the board of directors Retained Earnings 50,000 Accounting for Cash Dividend

There are three important dates relating the dividends. First is the date of declaration. Assume that on December 1, Hiber Corporation declares a $42,500 dividend. Accounting for Cash Dividend

Dec.1Cash Dividends Declared cash dividend. Cash Dividend Payable Date of Declaration Accounting for Cash Dividend

The second important date is the date of record. For Hiber Corporation this would be December 11. On this date, ownership of shares determines who receives the dividend. No entry is required. Accounting for Cash Dividend

The third important date is the date of payment. On January 2, Hiber issues dividend checks. 2 Accounting for Cash Dividend

Jan.2Cash Dividends Payable Paid cash dividends. Cash Date of Payment Accounting for Cash Dividend

A distribution of dividends to stockholders in the form of the firm’s own shares is called a stock dividend. Stock dividends transfer pro rata shares of stock to stockholders. Assume Hendrix Corporation declares a 5% stock dividend on common stock, $20 par, 2,000,000 shares issued. (Market price $31) Accounting for Stock Dividend

Dec.15Stock Dividends 3, Declared stock dividend. Hendrix Corporation, December 15 (before dividend) Common Stock, $20 par$40,000,000 Paid-in Capital in Excess of Par--Common Stock9,000,000 Retained Earnings26,600,000 Stock Dividends Distributable2, Paid-in Capital in Excess of Par—Common Stock1, Accounting for Stock Dividend

Jan. 10Stock Dividends Distributable 2, Issued stocks for the stock dividend. Common Stock2, On January 10, Hendix Corporation issues the stock. This action increases the number of shares outstanding by 100,000. Accounting for Stock Dividend

Hendrix Corporation, December 15 (before dividend) Common Stock, $20 par$40,000,000 Paid-in Capital in Excess of Par--Common Stock9,000,000 Retained Earnings 26,600,000 $75,600,000 Hendrix Corporation, January 10 (after dividend) Common Stock, $20 par$42,000,000 Paid-in Capital in Excess of Par--Common Stock10,100,000 Retained Earnings 23,500,000 $75,600,000 Accounting for Stock Dividend

There are two ways to report stockholders’ equity in the balance sheet. In the following slide, each class of stock is listed first, followed by its related paid-in capital accounts. The other slide shows the second method. Note that the stock accounts are listed first. The other paid-in capital accounts are listed as a single item described as Additional paid-in capital. Reporting Shareholder’s Equity

Paid-in capital: Preferred 10% stock, $50 par, cumulative (2,000 shares authorized and issued) $100,000 Excess of issue price over par 10,000$ 110,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued)$900,000 Excess of issue price over par 190,0001,090,000 From sale of treasury stock 2,000 Total paid-in capital$1,202,000 Retained earnings 350,000 Total$1,552,000 Deduct treasury stock (600 shares at cost) 27,000 Total stockholders’ equity$1,525,000 Shareholders’ Equity

Contributed capital: Preferred 10% stock, cumulative $50 par (2,000 shares authorized and issued) $100,000 Common stock, $20 par (50,000 shares authorized, 45,000 issued)900,000 Additional paid-in capital 202,000 Total contributed capital$1,202,000 Retained earnings 350,000 Total$1,552,000 Deduct treasury stock (600 shares at cost) 27,000 Total stockholders’ equity$1,525,000 Shareholders’ Equity