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

13 Corporations: Organization and Capital Stock Transactions 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.

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

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 McDonald’s Nike PepsiCo Google Cargill Inc. Alternative Terminology Privately held corporations are also referred to as closely held corporations. LO 1 Identify the major characteristics of a corporation.

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

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

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

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

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

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

Characteristics of an Organization Stockholders Illustration 13-1 Corporation organization chart 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 Treasurer Controller LO 1 Identify the major characteristics of a corporation.

The Corporate Form of Organization Forming a Corporation Alternative Terminology The charter is often referred to as the articles of incorporation. 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 engaged in interstate commerce must obtain a license from each state in which they do business. LO 1 Identify the major characteristics of a corporation.

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

* A number of companies have eliminated the preemptive right. The Corporate Form of Organization Stockholders Rights Illustration 11-3 3. 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). * A number of companies have eliminated the preemptive right. LO 1 Identify the major characteristics of a corporation.

The Corporate Form of Organization Stockholders Rights Illustration 11-3 4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. LO 1 Identify the major characteristics of a corporation.

Stock Issue Considerations Authorized Stock 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. LO 1 Identify the major characteristics of a corporation.

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

Stock Issue Considerations Issuance of Stock 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: Company’s anticipated future earnings. Expected dividend rate per share. Current financial position. Current state of the economy. Current state of the securities market. LO 1 Identify the major characteristics of a corporation.

Stock Issue Considerations Market Price of Stock 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. LO 1 Identify the major characteristics of a corporation.

Stock Issue Considerations Par and No-Par Value Stock 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. LO 1 Identify the major characteristics of a corporation.

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

> DO IT! 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 False False LO 1 Identify the major characteristics of a corporation.

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 to the corporation by stockholders in exchange for capital stock. LO 2 Differentiate between paid-in capital and retained earnings.

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. LO 2 Differentiate between paid-in capital and retained earnings.

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

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

Accounting for Common Stock Issues Issuing Par Value Common Stock for Cash 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. a. Cash 1,000 Common Stock (1,000 x $1) 1,000 b. Cash 5,000 Common Stock (1,000 x $1) 1,000 Paid-in Capital in Excess of Par Value 4,000 LO 3 Record the issuance of common stock.

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

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. Cash 40,000 Common Stock 25,000 Paid-in Capital in Excess of Stated Value 15,000

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. LO 3 Record the issuance of common stock.

Accounting for Common Stock Issues 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 Expense 5,000 Common Stock (4,000 x $1) 4,000 Paid-in Capital in Excess of par 1,000 LO 3 Record the issuance of common stock.

Accounting for Common Stock Issues 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 Par 30,000 LO 3 Record the issuance of common stock.

ANATOMY OF A FRAUD Total take: $7 billion 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. Total take: $7 billion 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. Advance slide in presentation mode to reveal answer.

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 LO 4 Explain the accounting for treasury stock.

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 the 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 the acquisition of other companies. To increase earnings per share. LO 4 Explain the accounting for treasury stock.

Accounting for Treasury Stock 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. Helpful Hint Treasury shares do not have dividend rights or voting rights. LO 4 Explain the accounting for treasury stock.

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

Accounting for Treasury Stock Illustration 13-9 Stockholders’ equity with 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. LO 4 Explain the accounting for treasury stock.

Accounting for Treasury Stock Disposal of Treasury Stock Sale 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. Above Cost Below Cost Both increase total assets and stockholders’ equity. LO 4 Explain the accounting for treasury stock.

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

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

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

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. LO 5 Differentiate preferred stock from common stock.

Preferred Stock 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. Cash 120,000 Preferred Stock (10,000 x $10) 100,000 Paid-in Capital in Excess of Par – Preferred Stock 20,000 Preferred stock may have a par value or no-par value. LO 5 Differentiate preferred stock from common stock.

Preferred Stock Dividend Preferences 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 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 LO 5 Differentiate preferred stock from common stock.

Preferred Stock Liquidation Preferences 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.

Statement Presentation Illustration 13-12 LO 6 Prepare a stockholders’ equity section.

A Look at IFRS Key Points 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. LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

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

A Look at IFRS Key Points 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. LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

A Look at IFRS Key Points 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. LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

A Look at IFRS Looking to the Future 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. LO 7 Compare the accounting procedures for stockholders’ equity under GAAP and IFRS.

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

A Look at IFRS IFRS Self-Test Questions Which of the following is true? In the United States, the primary corporate stockholders are financial institutions. Share capital means total assets under IFRS. The IASB and FASB are presently studying how financial statement information should be presented. 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.

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

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