1. Corporations: Paid-in Capital and the Balance Sheet
Chapter 11
Chapter 11 explains corporate paid-in capital and how its reported on the balance sheet.

2. Capital Stock
State authorizes how many shares of stock a corporation may issue through corporate bylaws
Corporation issues stock certificates when stockholders buy stock
Basic unit of stock is a share
Stock held by stockholders is outstanding
The state authorizes, in the bylaws of a corporation, how many shares of a stock class the corporation may issue. This is called authorization of stock. A corporation issues stock certificates to the stockholders when they buy the stock.
The stock certificate represents the individual’s ownership of the corporation’s capital, so it is called capital stock. The basic unit of stock is a share. A corporation may issue a stock certificate for any number of shares. Stock that is held by the stockholders is said to be outstanding. The outstanding stock of a corporation represents 100% of its ownership.
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3. Stockholders’ Equity Paid-in capital Retained earnings
Amounts received from stockholders
Common stock is main source
Externally generated
Resulting from transactions with outsiders
Earned by profitable operations
Internally generated
Results from internal corporate decisions and earnings
The two basic sources of stockholders’ equity are:
• Paid-in capital (also called contributed capital), which represents amounts received from the stockholders. Common stock is the main source of paid-in capital. This is externally generated capital and results from transactions with outsiders.
• Retained earnings, which is net equity earned by profitable operations. This is internally generated equity and results from internal corporate decisions and earnings.
Paid-in capital
Retained earnings

4. Classes of Stock Common stock Preferred stock
Basic form of capital stock
Owners have certain advantages over common
Receive dividends before common
Upon liquidation, receive assets before common
Right to vote sometimes withheld
Corporations can issue different classes of stock. The stock of a corporation may be either:
• common or preferred
• par or no-par
Every corporation issues common stock, which represents the basic ownership of the corporation. The real “owners” of the corporation are the common stockholders. Some companies issue Class A common stock, which carries the right to vote. They may also issue Class B common stock, which may be non-voting. There must be at least one voting “class” of stock. However, there is no limit as to the number or types of classes of stock that a corporation may issue. Each class of stock has a separate account.
Preferred stock gives its owners certain advantages over common. Most notably, preferred stockholders receive dividends before the common stockholders. They also receive assets before common stockholders if the corporation liquidates. Corporations pay a fixed dividend on preferred stock, which is printed on the face of the preferred stock certificate. Investors usually buy preferred stock to earn those fixed dividends. With these advantages, preferred stockholders take less investment risk than common stockholders.
Owners of preferred stock also have the four basic stockholder rights, unless a right is withheld. The right to vote, however, is usually withheld from preferred stock. Companies may issue different series of preferred stock (Series A and Series B, for example). Each series is recorded in a separate account.
Common stock
Preferred stock

5. Par and No-par Par value No-par
Arbitrary amount assigned by company to a share of stock
Usually set low as to avoid legal difficulties
No arbitrary amount assigned by company to a share of stock
Stock may carry a par value, or it may be no-par stock. Par value is an arbitrary amount assigned by a company to a share of its stock. Most companies set par value low to avoid legal difficulties from issuing their stock below par.
Companies maintain a minimum amount of stockholders’ equity for the protection of creditors, and this minimum represents the corporation’s legal capital. No-par stock does not have par value. But some no-par stock has a stated value, an arbitrary amount similar to par value. Usually the state the company incorporates in will determine whether a stock may be par or stated value stock. As far as accounting for it goes, par is treated the same as stated value.
Par value
No-par

6. Accounting for the Issuance of Stock
Issue stock at par
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Cash
Common stock
Most often corporations issue stock for cash. If stock is issued at par value, this journal entry is made. The Common stock account is credited for the number of shares multiplied by the par value.
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7. Accounting for the Issuance of Stock
Issue stock at a premium
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Cash
Common stock
Paid-in capital in excess of par
Usually, the issue price exceeds par value because par value is normally set quite low. The amount above par is called a premium. A premium on the sale of stock is not a gain, income, or profit for the corporation because the company is dealing with its own stock.
This situation illustrates one of the fundamentals of accounting: A company can have no profit or loss when buying or selling its own stock. So, the premium is another type of paid-in capital account called “Paid-in capital in excess of par.” It is also called Additional paid-in capital.
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8. Accounting for Stock Issuances
No-par stock
No “Paid-in capital in excess of par” account needed
Full amount received is credited to “Common stock” account
Stated value stock
Similar to accounting for par value stock
Amount above stated value is credited to “Paid-in capital in excess of stated value”
When a company issues no-par stock, it debits the asset received and credits the stock account. For no-par stock, there can be no paid-in capital in excess of par, because there isn’t any par to be in excess of. Accounting for no-par stock with a stated value is almost identical to accounting for par-value stock. The only difference is that no-par stock with a stated value uses an account titled Paid-in capital in excess of stated value to record amounts received above the stated value.
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9. Accounting for Stock Issuances
Issuing stock for noncash assets
Asset is debited for its fair value
Issuing preferred stock
Similar to issuing common stock, except “Preferred stock” is credited at par value
Preferred stock usually is not issued above par
A corporation may issue stock for assets other than cash. It records the assets received at their current market value and credits the stock accounts accordingly. The assets’ prior book value is irrelevant. Accounting for preferred stock follows the pattern illustrated for issuing common stock. Most preferred stock is issued at par value. Therefore, Paid-in capital in excess of par is rare for preferred stock.
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10. This is an example of a stockholders’ equity section of the balance sheet.
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11. Exercise 11-15 Oct 19 Cash (1300 x $12) 15,600 Common stock 1,300
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Oct 19
Cash (1300 x $12)
15,600
Common stock
1,300
Paid-in capital in excess of par-C/S
14,300
Nov 3
Cash
10,000
Preferred stock 11
Equipment
18,000
6,000
12,000
Exercise demonstrates the accounting of stock issuances. On October 19, the company issued 1,300 shares of its $1 par common stock for $12 per share. Cash is increased by $15,600. Common stock is credited at par value and the premium is credited to Paid-in capital in excess of par-C/S. On November 3, the company issued 200 shares of its no-par preferred for $10,000. Cash is debited and Preferred stock is credited for $10,000. On November 11, the company exchanged 6,000 shares of its common stock for equipment valued at $18,000. The Equipment account is debited for the fair value. Common stock is credited at par value and Paid-in capital in excess of par-C/S is credited for the premium.
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12. Retained Earnings Income Summary Expenses Revenues Net Income
Closing entry #1
Closing entry #2
Expenses
Revenues
Net Income
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Income summary
Retained earnings
Recall that corporations close their revenues and expenses into Income summary. Then, they close net income (or loss) to Retained earnings. Net income is illustrated.
Closing entry #3

13. Deficit Balance
If a company incurs a loss, Retained earnings is decreased
A debit balance in Retained earnings is called a deficit
A loss may cause a debit balance in Retained earnings. This condition—called a Retained earnings deficit—is reported as a negative amount in stockholders’ equity.
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14. Dividend Dates Declaration date Date of record Payment date
A corporation declares a dividend before paying it. Three dividend dates are relevant:
1. On the declaration date, the board of directors announces the intention to pay the dividend. The declaration of a cash dividend creates an obligation (liability) for the corporation.
2. Those stockholders holding the stock at the end of business on the date of record—a week or two after declaration-- will receive the dividend check.
3. Payment of the dividend usually follows the record date by a week or two.
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15. Dividends Preferred dividends expressed as either:
A percent of par value
Or a flat dollar amount per share
Common dividends expressed as a dollar amount per share
2,000 shares of $100 par 8% preferred = $16,000 dividend
2,000 shares of no-par $3 preferred = $6,000 dividend
The cash dividend rate on preferred stock is often expressed as a percentage of the preferred-stock par value, such as 6%. But sometimes cash dividends on preferred stock are expressed as a flat dollar amount per share, such as $2 per share. Therefore, preferred dividends are computed two ways, depending on how the preferred-stock cash-dividend rate is expressed. Cash dividends on common stock are computed the second way, because those cash dividends are not expressed as a percentage.
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16. Accounting for Dividends
GENERAL JOURNAL
DATE
DESCRIPTION
REF
DEBIT
CREDIT
Retained earnings
Dividends payable
Declaration of cash dividend
Cash
Payment of cash dividend
To account for the declaration of a cash dividend, we debit Retained earnings and credit Dividends payable on the date of declaration. To pay the dividend on the payment date, debit Dividends payable and credit Cash.
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17. Dividing Dividends Between Preferred and Common
Preferred stockholders receive dividends before common
Common stockholders will only receive dividends if total declared is large enough
When a company has issued both preferred and common stock, the preferred stockholders get their dividends first. The common stockholders receive dividends only if the total dividend is in excess of the preferred dividend required. In other words, the common stockholders get the leftovers.
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18. Dividend Example A corporation has the following shares outstanding:
10,000 shares of $50 par, 6% preferred stock
50,000 share of $1 par common stock
Preferred dividend = 10,000 x $50 x 6% = $30,000
Situation 1: A $50,000 cash dividend is declared
An example illustrates how dividends are split among preferred and common shareholders. A corporation has 10,000 shares of $50 par, 6% preferred stock. This means preferred must receive $30,000 before common receives any dividends. In situation one, a $50,000 dividend is declared. Preferred will receive its $30,000 and common will receive the remaining $20,000. In situation two, only a $25,000 dividend is declared. Preferred will receive all $25,000 and common will not receive any dividend.
Situation 2: A $25,000 cash dividend is declared
Preferred receives $30,000
Common receives $20,000
Preferred receives $25,000
Common receives nothing
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19. Cumulative and Noncumulative Preferred Stock
Accumulates dividends each year until the dividends are paid
Dividends in arrears - dividends passed or not paid
Noncumulative preferred stock
Dividends not paid do not accumulated from one year to the next
Preferred stock can be either cumulative or noncumulative. Most preferred stock is cumulative. As a result, preferred is assumed to be cumulative unless it’s specifically designated as noncumulative. A corporation may fail to pay the preferred dividend if, for example, it does not have cash to fund the dividend. This is called passing the dividend, and the dividends are said to be in arrears. Cumulative preferred-stock shareholders must receive all dividends in arrears before the common stockholders get any dividend. .
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20. Preferred dividend = 5,000 x $15 x 5% = $3,750
Problem 11-33A
Preferred dividend = 5,000 x $15 x 5% = $3,750
a) noncumulative
Year
Preferred
Common
2010
$2,000
2011
Preferred dividend
Remainder
$13,000
2012
$18,000
Problem shows how cumulative and noncumulative preferred differ.
Hip Skincare has 5,000 shares of 5%, $15 par value preferred stock and 80,000 shares of $2.25 par common stock outstanding. During a three-year period, Hip declared and paid cash dividends as follows: 2010, $2,000; 2011, $15,000; and 2012, $20,000. Preferred will receive the first $3,750 of dividends declared.
In part (a), the preferred stock is noncumulative. In 2010, only $2,000 of dividends are declared. Preferred receives all of it. Common gets nothing. The preferred shareholders will never receive the unpaid $1,750 from In 2011, $15,000 is declared. The first $2,000 goes to preferred and the remaining $13,000 goes to common. In 2012, the same pattern follows, except common receives $18,000
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21. Problem 11-33A (continued)
Preferred dividend = 5,000 x $15 x 5% = $3,750
b) cumulative
Year
Preferred
Common
2010
$2,000
2011
In arrears
$1,750
Current year
$3,750
Remainder
$11,250
2012
$18,000
In part (b) the preferred is cumulative. This means any unpaid dividends carry forward for preferred stockholders. So in 2010, the $1,750 is called dividend in arrears. In 2011, preferred will receive this amount plus the $2,000 current year dividend – totaling $3,750. Common will receive the remaining $11,250. In 2012, there are no dividends in arrears, so it is the same as part (a).
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22. Problem 11-33A GENERAL JOURNAL Retained earnings 15,000
DATE
DESCRIPTION
REF
DEBIT
CREDIT
2011 12 22
Retained earnings
15,000
Dividends payable – C/S
11,250
Dividends payable – P/S
3,750
2012 1 14
Cash
The journal entries for the 2011 declaration of dividends is shown here. This is for case (b), in which the preferred is cumulative. On January 14, 2012, the dividends were paid.
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23. Problem 11-33A (continued)
Preferred dividend = 5,000 x $15 x 5% = $3,750
b) cumulative
Year
Preferred
Common
2010
$2,000
2011
In arrears
$1,750
Current year
$3,750
Remainder
$11,250
2012
$18,000
In part (b) the preferred is cumulative. This means any unpaid dividends carry forward for preferred stockholders. So in 2010, the $1,750 is called dividend in arrears. In 2011, preferred will receive this amount plus the $2,000 current year dividend – totaling $3,750. Common will receive the remaining $11,250. In 2012, there are no dividends in arrears, so it is the same as part (a).
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24. Problem 11-33A GENERAL JOURNAL Retained earnings 15,000
DATE
DESCRIPTION
REF
DEBIT
CREDIT
2011 12 22
Retained earnings
15,000
Dividends payable – C/S
11,250
Dividends payable – P/S
3,750
2012 1 14
Cash
The journal entries for the 2011 declaration of dividends is shown here. This is for case (b), in which the preferred is cumulative. On January 14, 2012, the dividends were paid.
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25. Different Values of Stock
Market value
Price at which a person can buy or sell a share
Most important to shareholders
Liquidation value
Amount guaranteed to preferred if company liquidates
Book value
Amount of equity per one share of stock
There are several different stock values in addition to par value. Market value, book value, and liquidation value are all used for decision making. Market value, or market price, is the price for which a person can buy or sell a share of stock. The corporation’s net income and general economic conditions affect market value. The Internet and most newspapers report stock prices. Log on to any company’s Web site to track its stock price, which usually changes daily. In almost all cases, stockholders are more concerned about the market value of a stock than about any other value.
Liquidation value is the amount that is guaranteed to the preferred shareholders in the event a company liquidates. If a liquidation value exists, it will be printed on the face of the preferred stock certificate. Note that this value only has meaning if the corporation liquidates. Book value per share of stock is the amount of stockholders’ equity on the company’s books for each share of its stock.
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26. Book Value per Share Book value of preferred stock:
Liquidation price or Preferred stock account A
Dividends in arrears on any outstanding preferred shares B
Total book value attributed to preferred stock
A+B
Number of outstanding preferred shares C
Book value per share of preferred stock
(A+B)/C
Book value of common stock:
Total stockholders’ equity D
Less: book value attributed to preferred
A+B
Total book value attributed to common stock
D-(A+B)
Number of outstanding common shares E
Book value per share of common stock
D-(A+B)/E
If the company has both preferred and common outstanding, owners of preferred stock have first claim to the equity—just like they have first claim to the dividends. Therefore, we subtract preferred equity from total equity to compute book value per share of common. The preferred equity is either the liquidation price x outstanding shares or par value of the preferred shares issued. Also, any dividends in arrears are included in book value attributed to preferred shares. The book value attributed to preferred stock is divided by the number of outstanding preferred shares to get the book value of preferred stock.
To determine the book value of common, preferred book value is subtracted from total stockholders’ equity. This is called common equity. This amount is divided by the number of common shares outstanding.
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27. Rate of Return on Total Assets
Net income + Interest expense
Average total assets
The rate of return on total assets, or simply return on assets, measures a company’s success in using assets to earn income. Two groups invest money to finance a corporation:
• Stockholders
• Creditors
Net income and interest expense are the returns to these two groups. The stockholders earn the corporation’s net income, and the creditors get its interest expense.
The sum of net income plus interest expense is the numerator of the return-on-assets ratio. The denominator is average total assets (Beginning total assets plus ending total assets divided by 2). Net income and interest expense are taken from the income statement. Average total assets comes from the beginning and ending balance sheets.
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28. Rate of Return on Common Stockholders’ Equity
Net income – Preferred dividends
Average common stockholders’ equity
Rate of return on common stockholders’ equity, often shortened to return on equity, shows the relationship between net income available to the common stockholders and their average common equity. The numerator is net income minus preferred dividends. Preferred dividends are subtracted because the preferred stockholders have first claim to any dividends. The denominator is average common stockholders’ equity—total equity minus preferred equity (Beginning equity + Ending equity divided by 2).
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29. End of Chapter 11
This concludes Chapter 11.