McGraw-Hill/Irwin 13-1 © The McGraw-Hill Companies, Inc., 2005 Accounting for Corporations Chapter 13

McGraw-Hill/Irwin 13-2 © The McGraw-Hill Companies, Inc., 2005 Privately Held Publicly Held Ownership can be Corporate Form of Organization Existence is separate from owners. An entity created by law. Has rights and privileges.

McGraw-Hill/Irwin 13-3 © The McGraw-Hill Companies, Inc., 2005 Advantages  Separate Legal Entity  Limited Liability of Stockholders  Transferable Ownership Rights  Continuous Life  Stockholders Are Not Corporate Agents  Ease of Capital Accumulation Disadvantages  Governmental Regulation  Corporate Taxation Advantages  Separate Legal Entity  Limited Liability of Stockholders  Transferable Ownership Rights  Continuous Life  Stockholders Are Not Corporate Agents  Ease of Capital Accumulation Disadvantages  Governmental Regulation  Corporate Taxation Characteristics of Corporations

McGraw-Hill/Irwin 13-4 © The McGraw-Hill Companies, Inc., 2005 Stockholders Board of Directors President, Vice-President, and Other Officers Employees of the Corporation Organizing and Managing a Corporation

McGraw-Hill/Irwin 13-5 © The McGraw-Hill Companies, Inc., 2005 Ultimate control. Stockholders usually meet once a year. Organizing and Managing a Corporation Selected by a vote of the stockholders. Overall responsibility for managing the company.

McGraw-Hill/Irwin 13-6 © The McGraw-Hill Companies, Inc., 2005  Vote at stockholders’ meetings.  Sell stock.  Purchase additional shares of stock.  Receive dividends, if any.  Share equally in any assets remaining after creditors are paid in a liquidation.  Vote at stockholders’ meetings.  Sell stock.  Purchase additional shares of stock.  Receive dividends, if any.  Share equally in any assets remaining after creditors are paid in a liquidation. Rights of Stockholders

McGraw-Hill/Irwin 13-7 © The McGraw-Hill Companies, Inc., 2005 Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Stock Certificates and Transfer When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate.

McGraw-Hill/Irwin 13-8 © The McGraw-Hill Companies, Inc., 2005 Basics of Capital Stock Total amount of stock that a corporation’s charter authorizes it to sell.

McGraw-Hill/Irwin 13-9 © The McGraw-Hill Companies, Inc., 2005 Basics of Capital Stock Total amount of stock that has been issued to stockholders.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Par value is an arbitrary amount assigned to each share of stock when it is authorized. Market price is the amount that each share of stock will sell for in the market. Selling (Issuing) Stock 

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Par Value Par Value No-Par Value No-Par Value Stated Value Stated Value Classes of Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Record: 1.The cash received. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Issuing Par Value Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Issuing Par Value Stock Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Let’s record this transaction.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Issuing Par Value Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Record: 1.The asset received at its market value. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Record: 1.The asset received at its market value. 2.The number of shares issued × the par value per share in the Common Stock account. 3.The remainder is assigned to Contributed Capital in Excess of Par. Issuing Stock for Noncash Assets Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Issuing Stock for Noncash Assets Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction. Par Value Stock On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 A separate class of stock, typically having priority over common shares in... Dividend distributions. Distribution of assets in case of liquidation. A separate class of stock, typically having priority over common shares in... Dividend distributions. Distribution of assets in case of liquidation. Usually has a stated dividend rate. Normally has no voting rights. Preferred Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Vs.NoncumulativeCumulative Dividends in arrears must be paid before dividends may be paid on common stock. Undeclared dividends from current and prior years do not have to be paid in future years. Cumulative or Noncumulative Dividend Most preferred stock is cumulative.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Example: Consider the following partial Statement of Stockholders’ Equity The Board of Directors did not declare or pay dividends in In 2005, the Board of Directors declare and pay cash dividends of $42,000. Cumulative or Noncumulative Dividend

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Cumulative or Noncumulative Dividend

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Vs.NonparticipatingParticipating Dividends may exceed a stated amount once common stockholders receive a dividend equal to the preferred stated rate. Dividends are limited to a maximum amount each year. The maximum is usually the stated dividend rate. Participating or Nonparticipating Dividend Most preferred stock is nonparticipating.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Reasons for Issuing Preferred Stock  To raise capital without sacrificing control.  To boost the return earned by common stockholders through financial leverage.  To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low.  To raise capital without sacrificing control.  To boost the return earned by common stockholders through financial leverage.  To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 To pay a cash dividend the corporation must have: 1.A sufficient balance in retained earnings and 2.The cash necessary to pay the dividend. Cash Dividends

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Regular cash dividends provide a return to investors and almost always affect the stock’s market value. Dividends Stockholders June 30 Cash Dividends Corporation

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Three important dates Date of Declaration Record liability for dividend. Dividends Date of Record No entry required. Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Date of Declaration Record liability for dividend. Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. Entries for Cash Dividends

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Date of Record No entry required. Entries for Cash Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19. No entry required on February 19.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Date of Payment Record payment of cash to stockholders. Entries for Cash Dividends On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Created when a company incurs cumulative losses or pays dividends greater than total profits earned in other years. Deficits and Cash Dividends

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return. Stockholders Stock Dividends Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well. Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well. 100 Shares $1 par value HotAir, Inc. Common Stock 100 shares $1 par

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Small Stock Dividend Distribution is  25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Small Stock Dividend Distribution is  25% of the previously outstanding shares. Capitalize retained earnings for the market value of the shares to be distributed. Stock Dividends Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares. Large Stock Dividend Distribution is > 25% of the previously outstanding shares. Capitalize retained earnings for the minimum amount required by state law, usually par or stated value of the shares.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Here is the stockholders’ equity section of Quest’s balance sheet prior to the declaration of a small stock dividend. Recording a Small Stock Dividend

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 On December 31, 2005, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, Let’s make the December 31 entry. Recording a Small Stock Dividend 100,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 2,000 × $1 par = $2, ,000 × 2% = 2,000 × $10 = $20,000 2,000 × $1 par = $2,000 2,000 × $1 par = $2,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Before the stockdividend. After the stockdividend.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Router, Inc. shows the following stockholders’ equity section just prior to issuing a large stock dividend. Recording a Large Stock Dividend

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 On December 31, 2005, Router declared a 40% stock dividend, when the stock was selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share. 50,000 × 40% = 20,000 shares × $1 par value = $20,000 Recording a Large Stock Dividend

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 A distribution of additional shares of stock to stockholders according to their percent ownership. Common Stock $10 par value 100 shares Old Shares New Shares Common Stock $5 par value 200 shares Stock Splits

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Thomas, Inc. has the following stockholders’ equity section just prior to a 2-for-1 stock split. Stock Splits

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this... No accounting entry is made. No accounting entry is made. Stock Splits

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Corporations acquire shares of their own stock. Why would a company do that? Why would a company do that? Use the shares to acquire control of another corporation. Use the shares to acquire control of another corporation. To avoid a hostile takeover. To avoid a hostile takeover. Use the shares for employee stock options. Use the shares for employee stock options. To maintain a strong market for its stock or show management confidence in the current price. To maintain a strong market for its stock or show management confidence in the current price. Use the shares to acquire control of another corporation. Use the shares to acquire control of another corporation. To avoid a hostile takeover. To avoid a hostile takeover. Use the shares for employee stock options. Use the shares for employee stock options. To maintain a strong market for its stock or show management confidence in the current price. To maintain a strong market for its stock or show management confidence in the current price. Treasury Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Treasury Stock

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000. Purchasing Treasury Stock Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet. Treasury stock is shown as a reduction in total stockholders’ equity on the balance sheet.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 On June 30, Whitt sold 100 shares of its treasury stock for $4 per share. Selling Treasury Stock at Cost $8,000 ÷ 2,000 shares = $4 cost per treasury share

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share. Selling Treasury Stock Above Cost

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 On August 27, Whitt sold an additional 400 shares of its treasury stock for $1.50 per share. Selling Treasury Stock Below Cost

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Net Income Reporting Income and Equity Discontinued Segments Changes in Accounting Principle Extraordinary Items Continuing Operations

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Revenues, expenses and income generated by the company’s continuing operations. Revenues, expenses and income generated by the company’s continuing operations. Continuing Operations Net Income Continuing Operations

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Income from operating the discontinued segment prior to its disposal and gain or loss on the sale of the net assets of the segment. Discontinued Segments Net Income Discontinued Segments

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 A gain or loss that is unusual in nature and infrequent in occurrence. A gain or loss that is unusual in nature and infrequent in occurrence. Extraordinary Items Net Income Extraordinary Items

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 The increase or decrease in income when changing from one generally accepted accounting principle to another. The increase or decrease in income when changing from one generally accepted accounting principle to another. Changes in Accounting Principles Net Income Changes in Accounting Principle

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Income Statement

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Campus, Inc. prepared the following schedule in connection with its change from double- declining balance to straight-line depreciation for an asset purchased in Campus is subject to a 20% income tax rate. Campus is subject to a 20% income tax rate. Changes in Accounting Principles

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Campus, Inc. prepared the following schedule in connection with its change from double- declining balance to straight-line depreciation for an asset purchased in The change to DDB would result in an after-tax increase in 2005’s net income of $48,000. Changes in Accounting Principles

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Earnings per share is one of the most widely cited items of accounting information. Earnings Per Share Basic earnings per share = Net income - Preferred dividends Weighted-average common shares outstanding

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during The company started the year with 10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury shares on September 30, Changes in Shares Outstanding

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 EPS = $75,000 - $10,000 $75,000 - $10,00012,500 = $5.20 Changes in Shares Outstanding Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during The company started the year with 10,000 shares of common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury shares on September 30, 2005.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 The right to purchase common stock at a fixed price over a specified period of time. As the stock’s price rises above the fixed option price, the value of the option increases. Option purchase price $30 per share. Stock Options Market price of stock $75 per share.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Options are given to key employees to motivate them to: focus on company performance, take a long-run perspective, and remain with the company. Options are given to key employees to motivate them to: focus on company performance, take a long-run perspective, and remain with the company. Stock Options

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Total cumulative amount of reported net income less any net losses and dividends declared since the company started operating. Statement of Retained Earnings

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Legal Contractual Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Most states restrict the amount of treasury stock purchases to the amount of retained earnings. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings. Restricted Retained Earnings

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 A corporation’s directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities. Appropriated Retained Earnings

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Correction of material errors in past years’ financial statements. If an amount is incorrectly expensed, add amount to Retained Earnings. Prior Period Adjustments

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Statement of Stockholders’ Equity This is a more inclusive statement than the statement of retained earnings.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Records amount of stockholders’ equity applicable to common shares on a per share basis. Book Value per Share—Common Book value per common share = Stockholders’ equity applicable to common shares Number of common shares outstanding

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Records amount of stockholders’ equity applicable to preferred shares on a per share basis. Book Value per Share—Preferred Book value per preferred share = Stockholders’ equity applicable to preferred shares Number of preferred shares outstanding

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 Tells us the annual amount of cash dividends distributed to common stockholders relative to the stock’s market price. Dividend Yield DividendYield= Annual cash dividends per share Annual cash dividends per share Market value per share

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities. If earnings go up, will the market price of my stock follow? Price Earnings Price-Earnings= Market value per share Market value per share Earnings per share

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2005 End of Chapter 13