Corporations: Organization, Stock Transactions, and Dividends LO 1 – Understanding the Nature of a Corporation

Characteristics of a Corporation LO 1 Characteristics of a Corporation A corporation is a legal entity, distinct and separate from the individuals who create and operate it. As a legal entity, a corporation may acquire, own, and dispose of property in its own name. A corporation sells shares of ownership, called stock. A corporation is a legal entity, distinct and separate from the individuals who create and operate it. As a legal entity, a corporation may acquire, own, and dispose of property in its own name.

Characteristics of a Corporation LO 1 Characteristics of a Corporation The stockholders or shareholders who own the stock own the corporation. They can buy and sell stock without affecting the corporation’s operations or continued existence. Corporations whose shares of stock are traded in public markets are called public corporations. The owners of a corporation are called shareholders or stockholders. Although a corporation is actually a collection of individual owners, or shareholders, legally it is treated as an artificial entity, separate from and independent of the owners. The shares of public corporations are traded on stock exchanges.

Characteristics of a Corporation LO 1 Characteristics of a Corporation Corporations whose shares are not traded publicly are usually owned by a small group of investors and are called nonpublic or private corporations. The stockholders of all corporations have limited liability. Private, or nonpublic, corporations are usually owned by small groups of investors. Their shares are not traded on stock exchanges. Public corporations are subject to the regulations of the SEC.

Characteristics of a Corporation LO 1 Characteristics of a Corporation The stockholders control a corporation by electing a board of directors. This board meets periodically to establish corporate policy. It also selects the chief executive officer (CEO) and other major officers. The stockholders elect a board of directors, who make the major decisions for the corporation. The board of directors establish corporate policies and hire the management that operates the corporation. A stockholder’s influence on a corporation is dependent on the percentage of ownership. Each share of stock has one vote. The more stock a stockholder owns, the greater will be his or her power to influence the corporation.

Characteristics of a Corporation LO 1 Characteristics of a Corporation Stockholders Board of Directors Officers This slide illustrates the organizational structure of a corporation. Stockholders elect the board of directors, which hires officers to manage the company. The corporate officers hire employees. Employees

Characteristics of a Corporation LO 1 Characteristics of a Corporation A corporation has separate legal existence from its owners. A corporation has transferable units of ownership. A corporation has limited stockholders’ liability. A corporation is subject to taxes. Thus, the corporate form has the disadvantage of double taxation. A corporation exists separate from its owners, and therefore changes in owners have no effect upon its continuation. A corporation is able to raise large amounts of money from its shareholders. Stockholders of a corporation have limited liability. This means that creditors usually may not go beyond the assets of the corporation to satisfy their claims. Thus, the financial loss that a stockholder may suffer is limited to the amount invested.

Characteristics of a Corporation LO 1 Characteristics of a Corporation This slide summarizes the advantages of the corporate form. A corporation exists separately from its owners, so ownership is readily transferable, and the continuation of the corporation exists indefinitely. Corporations raise capital by selling shares of stock. Stockholders are able to transfer their shares of stock at any time. This ease of transfer is one of the reasons corporations are able to easily attract investors. A corporation has limited liability for investors. Investors’ losses are limited to their investment. Corporate debts cannot be satisfied by tapping the personal resources of owners. This limited liability enables corporations to attract many investors. (continued)

Characteristics of a Corporation LO 1 Characteristics of a Corporation The major disadvantages of a corporation include regulation and taxation. Corporations are separate legal entities that must pay taxes on income. Additionally, dividends (withdrawals to owners) are taxed on the personal tax returns of stockholders. Since the board of directors makes most of the corporation’s decisions, a stockholder’s control is indirect. Unhappy stockholders have to vote for a new board of directors, if they want change.

LO 1 Forming a Corporation The first step in forming a corporation is to file an application of incorporation with the state. Because state laws differ, corporations often organize in states with more favorable laws. More than half of the largest companies are incorporated in Delaware. (See Exhibit 3, next slide.) Organizers file an application of incorporation with the state to form a corporation. The state of Delaware has laws that are very favorable to corporations. As a result, more than half of the largest companies are incorporated in Delaware.

Forming a Corporation LO 1 Many of the largest U.S. corporations have incorporated in Delaware because of its favorable regulations.

LO 1 Forming a Corporation After the application is approved, the state grants a charter, or articles of incorporation, which formally creates the corporation. Management and the board of directors then prepare bylaws, which are operating rules and procedures for conducting the corporation’s affairs. Once the application is approved, the state grants a charter ,or articles of incorporation, which formally creates the corporation. The board of directors prepares bylaws, which establish the rules of operation for the corporation.

LO 1 Forming a Corporation Costs may be incurred in organizing a corporation, such as legal fees, taxes, license fees, and promotional costs. The recording of a corporation’s organizing costs of $8,500 on January 5 is shown below: Costs may be incurred in organizing a corporation. These costs are recorded as expenses. The corporation debits Organizational Expense and credits Cash for $8,500 to record these fees.