John Wiley & Sons, Inc. Financial A ccounting, 5e Prepared by Kurt M. Hull, MBA CPA California State University, Los Angeles Weygandt, Kieso, & Kimmel

CHAPTER 12 CORPORATIONS CHAPTER 12 CORPORATIONS STUDY OBJECTIVES After studying this chapter, you should understand: Corporate characteristics Entries for cash dividends and stock dividends How to record the issuance of common stock Content of retained earnings statement Accounting for treasury stock Presentation & analysis Difference between common & preferred stock

STUDY OBJECTIVE 1 CORPORATE CHARACTERISTICS STUDY OBJECTIVE 1 CORPORATE CHARACTERISTICS Continuous life Management vs. ownership Government regulation Double taxation Ability to acquire capital Transferable ownership Limited liability Separate legal existence Advantages Disadvantages Corporations may be publicly or privately owned

FORMING A CORPORATION Steps to form a corporation Organizational costs are expensed as incurred. A. Application B. Charter C. By-laws

OWNERSHIP RIGHTS OF STOCKHOLDERS

STOCK ISSUE CONSIDERATIONS AuthorizedShares indicated by charter. IssuedShares sold to investors directly or indirectly. MarketSet by interaction between buyers and sellers. ParAssigned value/stated value/legal capital No parNo assigned value

STUDY OBJECTIVE 2 ISSUING COMMON STOCK STUDY OBJECTIVE 2 ISSUING COMMON STOCK Identify specific sources of paid-in capital Maintain the distinction between paid-in capital and retained earnings. Primary objectives in issuing common stock.

ISSUING PAR VALUE COMMON STOCK FOR CASH ISSUING PAR VALUE COMMON STOCK FOR CASH (record issuance at par) 1,000 Common Stock 1,000Cash1/1/xx CreditDebitAccountDate If the issue price = par value, proceeds are credited to common stock. Assume Hyrdo-Slide Inc., issues 1,000 shares of $1 par value common stock at par:

If the issue price par value, proceeds are split between common stock and paid-in capital in excess of par value Assume Hyrdo-Slide Inc., issues 1,000 shares of $1 par value common stock at $5 per share: ISSUING PAR VALUE COMMON STOCK FOR CASH ISSUING PAR VALUE COMMON STOCK FOR CASH 4,000 Paid-in capital in excess of par value (record issuance in excess of par) 1,000 Common Stock 5,000Cash1/1/xx CreditDebitAccountDate

REVIEW QUESTION On July 1, ABC Corporation issues 1,000 shares of $10 par value common stock at $12 per share. What is the entry to record this transaction? 2,000 Paid-in capital in excess of par value (record issuance in excess of par) 10,000 Common Stock 12,000CashJuly 1 CreditDebitAccountDate

Hydro-Slide, Inc. Balance Sheet (partial) Stockholders’ equity Paid-in-capital Common Stock$2,000 Total paid-in-capital6,000 Retained earnings27,000 Total stockholders’ equity$33,000 Paid-in-capital in excess of par value 4,000 The total paid-in-capital from these transactions is $6,000, and the legal capital is $2,000. If Hydro-Slide, Inc. has retained earnings of $27,000, the stockholders’ equity section is as follows: STOCKHOLDERS’ EQUITY SECTION

ISSUING NO-PAR COMMON STOCK FOR CASH ISSUING NO-PAR COMMON STOCK FOR CASH If issue price > stated value, the stated value is credited to common stock, and the excess goes to paid-in excess of stated value. If Hydro-Slide Inc. issues 5,000 shares of $5 stated value no-par stock for $8 per share: 15,000 Paid-in capital in excess of stated value (record issuance of stated value, no par shares) 25,000 Common Stock (5000 x $5) 40,000Cash1/1/xx CreditDebitAccountDate

ISSUING NO-PAR COMMON STOCK FOR CASH ISSUING NO-PAR COMMON STOCK FOR CASH (record issuance of no-par shares) 40,000 Common Stock 40,000Cash1/1/xx CreditDebitAccountDate If there is no stated value, proceeds are credited to common stock. If Hydro-Slide Inc. issues 5,000 shares of no stated value stock for $8 per share:

Attorneys helped Jordan Company incorporate, and have billed $5,000 for services. The attorneys accept 4000 shares of $1 par value common stock as payment. There is no established market price for the stock. ISSUING COMMON STOCK FOR SERVICES OR NON-CASH ASSETS ISSUING COMMON STOCK FOR SERVICES OR NON-CASH ASSETS 1,000 Paid-in capital in excess of par (record issuance of stock to attorneys) 4,000 Common Stock 5,000Organization Expense1/1/xx CreditDebitAccountDate COST IS: FMV of consideration given up OR FMV of consideration received whichever is more clearly determinable

1) To reissue shares to officers or employees 2) To increase trading & enhance market value 3) To have additional shares to buy other companies 4) To reduce shares outstanding, and increase EPS 5) To avoid a takeover by disgruntled investors. STUDY OBJECTIVE 3 ACCOUNTING FOR TREASURY STOCK STUDY OBJECTIVE 3 ACCOUNTING FOR TREASURY STOCK Treasury stock is a corporation's own stock that has been reacquired but not retired. Why do companies purchase treasury stock?

Before the purchase of the treasury stock, the stockholders’ equity is as follows: Mead, Inc. Balance Sheet (partial) Stockholders’ equity Paid-in capital Common stock, $5 par, 10,000 shares Issued and outstanding Retained earnings Total stockholders’ equity $ 500, ,000 $ 700,000 STOCKHOLDERS EQUITY SECTION WITH NO TREASURY STOCK STOCKHOLDERS EQUITY SECTION WITH NO TREASURY STOCK

If Mead, Inc. has 100,000 shares of $5 par value common stock outstanding (all issued at par value) and it decides to acquire 4,000 shares of its stock at $8 per share, the entry is: PURCHASE OF TREASURY STOCK (record purchase of treasury stock) 32,000 Cash 32,000Treasury stockFeb 1 CreditDebitAccountDate Cost method

Mead, Inc. Balance Sheet (partial) Stockholders’ equity Paid-in capital Common stock, $5 par, 100,000 shares issued and 96,000 shares outstanding Retained earnings Total paid-in capital and retained earnings Less: Treasury stock (4,000 shares) Total stockholders’ equity $500, , ,000 32,000 $668,000 STOCKHOLDERS EQUITY SECTION WITH TREASURY STOCK STOCKHOLDERS EQUITY SECTION WITH TREASURY STOCK The acquisition of treasury stock REDUCES stockholders’ equity The stockholders’ equity section of Mead, Inc. after purchase of treasury stock is as follows:

If 1,000 shares of treasury stock of Mead, Inc., previously acquired at $8 per share, are sold at $10 per share on July 1. The entry is: DISPOSAL OF TREASURY STOCK ABOVE COST DISPOSAL OF TREASURY STOCK ABOVE COST 2,000 Paid-in capital from treasury stock (record sale of treasury stock above cost) 8,000 Treasury Stock 10,000CashJuly 1 CreditDebitAccountDate The $2,000 credit is NOT A GAIN on Sale of Treasury Stock

If Mead, Inc. sells an additional 800 shares of treasury stock on October 1 at $7 per share, the entry is: DISPOSAL OF TREASURY STOCK BELOW COST DISPOSAL OF TREASURY STOCK BELOW COST 6,400 Treasury stock (record sale of treasury stock below cost) 800Paid-in capital from treasury stock 5,600CashOct 1 CreditDebitAccountDate The sale of treasury stock increases TOTAL ASSETS and STOCKHOLDERS’ EQUITY

If Mead, Inc., sells its remaining 2200 shares at $7 per Share on December 1, the entry is: DEPLETING THE BALANCE IN PAID-IN CAPITAL FROM TREASURY STOCK DEPLETING THE BALANCE IN PAID-IN CAPITAL FROM TREASURY STOCK 1,000Retained earnings 17,600 Treasury stock (record sale of 2200 shares of treasury stock) 1,200Paid-in capital from treasury stock 15,400CashDec 1 CreditDebitAccountDate When the credit balance in paid-in capital from treasury stock is depleted, the difference is debited to RETAINED EARNINGS.

Preferred stock has priority over common stock in terms of No voting rights. Identified separately from other stock and paid in capitals. STUDY OBJECTIVE 4 PREFERRED STOCK STUDY OBJECTIVE 4 PREFERRED STOCK Distribution of earnings Assets in liquidation

CUMULATIVE DIVIDEND Preferred stockholders must be paid both current and prior year dividends before common stockholders receive any dividends. DIVIDENDS IN ARREARS Preferred dividends not declared in a given period. Not considered a liability, but disclosed in the notes to the financial statements. DIVIDEND PRFERENCES

Dividends in arrears ($35,000 x 2) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000 CUMULATIVE DIVIDEND If Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding. The annual dividend Is $35,000 (5,000 shares x $7 per share). If dividends are two years in arrears, preferred stockholders should receive the following before any dividends are paid to common stockholders.

STUDY OBJECTIVE 5 CASH AND STOCK DIVIDENDS STUDY OBJECTIVE 5 CASH AND STOCK DIVIDENDS (declaration of a cash dividend) 50,000 Dividends payable 50,000Retained earningsDec 1 CreditDebitAccountDate On December 1, 2006, Media General declares a 50 cents per share dividend on 100,000 shares of $10 par value stock: Declaration Date

STUDY OBJECTIVE 5 CASH AND STOCK DIVIDENDS STUDY OBJECTIVE 5 CASH AND STOCK DIVIDENDS Dec 30 CreditDebitAccountDate RECORD DATE

STUDY OBJECTIVE 5 CASH AND STOCK DIVIDENDS STUDY OBJECTIVE 5 CASH AND STOCK DIVIDENDS (payment of cash dividend) 50,000 Cash 50,000Dividends payableJan 23 CreditDebitAccountDate On January 23, 2007, Media General pays the previously declared dividend. PAYMENT DATE

ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON Assume that IBR Inc. has 1,000 shares of 8%, $100 par cumulative preferred stock and 50,000 shares of $10 par common stock outstanding at December 31, If the Board of Directors declares a $6,000 cash dividend on December 31, the entire amount will go preferred stockholders because their annual dividend is $8,000,(1,000 shares x $8). (payment of cash dividend) 6,000 Dividends payable 6,000Retained earningsDec 31 CreditDebitAccountDate Preferred dividends are now $2000 in arrears

Total dividend $50,000 Allocated to preferred stock Remainder allocated to common stock $40,000 Dividend in arrears, 2002 (1,000 x $2) $2, dividend (1,000 x $8) 8,000 10,000 At December 31, 2007, IBR declares a $50,000 cash dividend. The allocation of the dividend is shown above. ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON

STOCK DIVIDENDS A pro rata distribution of stock to existing stockholders. Decreases retained earnings and increases in paid-in capital. Small dividend (< 20%) valued at FMV Large dividend (>20%) valued at Par/Stated No effect on Total Assets or Stockholders’ Equity.

ENTRIES FOR STOCK DIVIDENDS Medland Corporation has a balance of $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The FMV of its stock is $15 per share and the 5000 shares are issued. The following entries would be made at the date of declaration: (declaration of 10% stock dividend ) 25,000 Paid-in capital in excess of par 50,000 Common stock dividends distributable 75,000Retained earningsDeclaration CreditDebitAccountDate

STATEMENT PRESENTATION OF DIVIDENDS DISTRIBUTABLE Paid-in capital Common stock500,000 Common stock dividends distributable50,000550,000 Common Stock Dividends Distributable is a stockholders’ equity account. If a balance sheet is prepared before the dividend shares are issued, the distributable account is reported in paid-in capital. 50,000 Common stock 50,000Common stock dividends distributabledistribution (distribution of 10% stock dividend ) CreditDebitAccountDate The following entry is made when the stock dividend is distributed.

STOCK DIVIDEND EFFECTS 55,00050,000Outstanding shares $800,000 Total stockholders’ equity 225,000300,000 Retained earnings 575,000500,000 Total paid-in capital 25,0000 Paid-in capital in excess of par value $550,000$500,000 Common stock, $10 par Paid-in capital Stockholders’ equity After Dividend Before Dividend Stock dividends change the composition of stockholders’ equity because a portion of retained earnings is transferred to paid-in capital.

A multiple of existing shares issued to existing stockholders. Total number of shares increases, par value decreases. No effect on total stockholders’ equity. No journal entry required. STOCK SPLITS

100,00050,000Outstanding shares $800,000 Total stockholders’ equity 300,000 Retained earnings 500,000 Total paid-in capital 00 Paid-in capital in excess of par value $500,000 Common stock, $10 par Paid-in capital Stockholders’ equity After Split Before Split STOCK SPLIT EFFECTS 2 for 1 stock split.

REVIEW QUESTION Mickey Mouse Corporation has 450,000 shares of $3 par value common stock outstanding. If the company announces a 3 for 1 stock split, what affect will this have on shares outstanding and par value? $1.00 par value$3.00 par value 1350,000 shares450,000 shares After splitBefore split What is the journal entry to reflect the stock split? No journal entry required.

STUDY OBJECTIVE 6 RETAINED EARNINGS STUDY OBJECTIVE 6 RETAINED EARNINGS Net income that is retained in the business. Net losses reduce retained Earnings. Net losses are not debited to paid-in capital accounts. RETAINED EARNINGS Net loss Prior period adjustments (o) Dividends Some treasury stock disposals Net income Prior period adjustments (u)

$750,000 Total stockholders’ equity (50,000) Retained earnings (deficit) $800,000 Common stock Paid-in capital Stockholders’ equity STOCKHOLDERS’ EQUITY WITH DEFICIT Balance Sheet (partial) A debit balance in retained earnings is a DEFICIT.

Restrictions make a portion of the balance unavailable for dividends. RETAINED EARNINGS RESTRICTIONS RETAINED EARNINGS RESTRICTIONS CAUSES Legal Restrictions (treasury stock) Contractual Restrictions (loan covenants) Voluntary Restrictions (plant expansion)

PRIOR PERIOD ADJUSTMENTS Correction of a material error in reporting net income in previously issued financial statements. : 300,000 Accumulated depreciation 300,000Retained earnings2006 (adjust for PY understatement) CreditDebitAccountDate General Microwave understated 2005 depreciation expense by $300,000. They discover the error in 2006, and make the following corrective entry.

General Microwave Retained Earnings Statement (partial) Balance, January 1. as reported$800,000 Correction for prior period overstatement of net income (depreciation error) (300,000) Balance, January 1, as adjusted$500,000 PRIOR PERIOD ADJUSTMENTS A prior period adjustment is reported as an adjustment to the opening balance of retained earnings:

STUDY OBJECTIVE 7 PRESENTATION & ANALYSIS STUDY OBJECTIVE 7 PRESENTATION & ANALYSIS

RETURN ON EQUITY Net income less preferred dividends Average Common Stockholders Equity Return on Common Stockholders’ Equity = Measures how many dollars of net income were earned For every dollar invested by common stockholders

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