1. Accounting for Corporations
Chapter 13
Accounting for Corporations
Chapter 13: Accounting for Corporations

2. Corporate Form of Organization
An entity created by law
Ownership can be
Privately Held
Existence is separate from owners
Corporations are entities, created by law, that exist separately from their owners and that have rights and privileges. Corporations may be privately or publicly owned. Publicly owned corporations have additional reporting responsibilities beyond those of a privately held corporation.
Has rights and privileges
Publicly Held

3. Characteristics of Corporations
Advantages
Separate legal entity
Limited liability of shareholders
Transferable ownership rights
Continuous life
Lack of mutual agency for shareholders
Ease of capital accumulation
Disadvantages
Governmental regulation
Corporate taxation
The corporate form of organization has several advantages:
It is a separate legal entity that can enter into contracts and sue and be sued.
Stockholders’ losses are limited to the amount invested in the corporation.
Ownership rights are transferable.
The corporation continues in existence even when ownership changes.
Stockholders are not agents of the corporation and can not enter into contracts on the corporation’s behalf.
Capital needs can be met by selling more ownership in the corporation.
Two disadvantages include extra governmental regulations imposed on corporations and corporate taxation of earnings. Corporations pay taxes on their earnings and if they distribute a dividend to shareholders, the shareholders pay taxes on the dividends received. This is sometimes referred to as double taxation.

4. Corporate Organization and Management
Shareholders
Board of Directors
In general, the creation of a corporation begins when its organizers, called the promoters or incorporators, obtain a registration from a government body or the court. When the process is complete and fees paid, the registration is complete and the corporation is formed.
Organization expenses(also called organization costs) are the costs to organize a corporation; they include legal fees, promoters’ fees, and amounts paid to obtain a registration. The corporation records (debits)these costs to an expense account called Organization Expenses.
The ultimate control of a corporation rests with shareholders who control a corporation by electing its board of directors, or simply, directors.
President, Vice-President, and Other Officers
Employees of the Corporation

5. Rights of Shareholders
C 1
Vote at shareholders’ meetings
Sell shares
Purchase additional shares
Receive dividends, if any
Share equally in any assets remaining after creditors are paid in a liquidation
In addition to voting on important issues at annual meetings, shareholders have the right to buy and sells shares, to receive dividends when declared by the board of directors, and in the event of liquidation, they share equally in any remaining assets after creditors are paid.

6. Basics of Share Capital
Total number of shares that a corporation is authorized to sell or issue.
Total number of shares that has been sold or issued to shareholders.
Corporations must disclose information related to their shares, such as par value and number of shares authorized and issued. We can also find the number of shares actually issued by the company. In our example, the company has a total of 92,556,295 shares issued and outstanding. Notice that this ordinary share has a par value of $0.01. Low par values are normal in business. Let’s look at the meaning of par value.

7. Basics of Share Capital
Par value is an arbitrary amount assigned to each share when it is authorized.
Market price is the amount that each share will sell for in the market.
Classes of Shares
Par Value
No-Par Value
Stated Value
Par value is an arbitrary amount assigned to each share. Par value is typically a nominal amount, and is not related in any manner to market value which is the selling price of a share.
In addition to par value stock, some states permit no-par, stated value ordinary share, or no par value ordinary share.

8. Issuing Par Value Share
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value for $25 per share. Let’s record this transaction.
When par value stock is sold for cash, the Share Capital account is credited for the par value of the shares sold. Remember that par value and market value are not related. The difference between the par value of the shares and the market value of the shares is credited to Contributed Capital in Excess of Par. If you added together the amount of par value in the Share Capital account and the amount in the Paid-In Capital in Excess of Par, Common Stock, you would have the market value of the sale of the shares. Let’s record the entry for Matrix Incorporated for the issue of 100,000 shares of $2 par value shares for $25 per share in cash.
Matrix would debit Cash for the market value of the shares sold: 100,000 shares times $25 per share. Matrix would credit Share Capital for the par value of the share sold: 100,000 shares times $2 per share. And, they would credit Share Premium, for the excess of market over par: 100,000 shares times $23 per share.

9. Issuing Par Value Shares
This is the way Matrix would report the ordinary shares on its balance sheet. The $200,000 is the par value of the shares sold and the $2,300,000 is the excess over par value Matrix received for the shares. These two amounts added together total $2,500,000, the amount of cash received for the sale of the shares.

10. Issuing Shares for Noncash Assets
P 1
Par Value Shares
On September 1, Matrix, Inc. issued 100,000 shares of $2 par value for land valued at $2,500,000. Let’s record this transaction.
A similar situation occurs when par value shares are exchanged for noncash assets. The Share Capital account is credited for the par value of the stock sold. The difference between the par value of the stock and the market value of the assets received is credited to Contributed Capital in Excess of Par. If you added together the amount of par value in the Share Capital account and the amount in the Paid-In Capital in Excess of Par, Common Stock, you would have the market value of the assets received. Let’s record the entry for Matrix Incorporated for the issue of 100,000 shares of $2 par value stock for land valued at $2,500,000.
Matrix would debit Land for its market value. Matrix would credit Share Capital for the par value of the share sold: 100,000 shares times $2 a share. And, they would credit Share Premium, for the excess of land’s market value in excess of the par value.

11. Cash Dividends
P 2
Regular cash dividends provide a return to investors and almost always affect the share’s market value.
Shareholders
Dividends
Corporation
Stockholders receive a return on their investment in two ways: one is through increases in the market value of the stock and one is through cash dividends.
To pay a cash dividend, a corporation must have two things:
 Sufficient retained earnings to absorb the dividend without creating a deficit; and
 Enough cash to pay the dividend.
To pay a cash dividend, the corporation must have:
A sufficient balance in retained earnings; and
The cash necessary to pay the dividend.

12. Accounting for Cash Dividends
P 2
Three important dates
Dividends
There are three important dates to remember when discussing dividends:
 The date of declaration is the date the directors declare the dividend. At this time, a liability is created and must be recorded.
 The date of record is important because you must own the stock on this date to receive the dividend. No entry is required in the accounting records.
The date of payment is the date the corporation pays the dividend to the shareholders who owned the stock on the record date.
Date of Declaration
Date of Record
Date of Payment
Record liability
for dividend.
No entry
required.
Record payment of
cash to shareholders.

13. Accounting for Cash Dividends
P 2
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 ordinary shares outstanding. The dividend will be paid on March 19 to shareholders of record on February 19.
Date of Declaration
Record liability
for dividend.
Dividends
Dana Incorporated declared a $1 per share dividend on January 19th on its 10,000 common shares outstanding. Let’s record the entry on the date of declaration.
The entry on January 19th includes a debit to Retained Earnings and a credit to Common Dividend Payable of $10,000.

14. Accounting for Cash Dividends
P 2
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 ordinary shares outstanding. The dividend will be paid on March 19 to shareholders of record on February 19.
No entry required on February 19, the date of record.
Date of Payment
Record payment of
cash to shareholders.
On February 19th, the record date, we need to know who owns the shares, but an accounting entry is not needed. Let’s record the entry on the date of payment.
On March 19th, the payment date, Dana Incorporated would debit Ordinary Dividend Payable and credit Cash for the $10,000 dividend.

15. Share Dividends or Bonus Issue
P 2
A distribution of a corporation’s own shares to its shareholders without receiving any cash payment in return.
Why a share dividend?
Can be used to keep the market price on the shares affordable.
Can provide evidence of management’s confidence that the company is doing well.
Capitalization: Transferring a portion of equity from retained earnings to contributed capital.
Sometimes corporations will distribute additional shares of stock as a dividend. Reasons for doing this include keeping the market price affordable by increasing the number of shares outstanding and providing evidence of management’s confidence in the company.
A share dividend or a bonus issue is treated as a “capitalization.” This suggests transferring a portion of equity from retained earnings to contributed capital. The journal entry should be to debit Retained Earnings and to credit Share Capital. The new shares are issued at a price to be decided by a director’s resolution. This price is likely to be made with reference to a market price, if available.

16. Share Splits
P 2
A distribution of additional shares to shareholders according to their percent ownership.
$10 par value
Old
Shares
Ordinary Shares
100 shares
A share split is the distribution of additional shares to shareholders according to their percent ownership. When a share split occurs, the corporation calls in the outstanding shares and issues new shares. In the process of a share split, the par value of the share changes.
After the split, the number of shares doubled and the par value was cut in half. There is no change in total par value. The old shares had a total par value of $1,000 (100 shares times $10 per share par value). The new shares have a total par value of $1,000 (200 shares times $5 par value per share). Notice that an accounting entry is not required, and that Retained Earnings is not reduced.
In many respects, a 100 percent stock dividend and a two-for-one stock split result in similar impacts in the market price of the share outstanding. The stock split usually requires more administrative tasks to call in and reissue stock certificates. However, sometimes corporations do not reissue certificates in a stock split, saving some of the administrative costs.
$5 par value
New
Shares
Ordinary Shares
200 shares

17. Usually has a stated dividend rate Normally has no voting rights
Preference Shares
C 2
A separate class of shares, typically having priority over ordinary shares in . . .
Dividend distributions
Distribution of assets in case of liquidation
Usually has a stated dividend rate
Preferred shares are a separate class of shares that typically has priority over ordinary shares in dividend distributions and distribution of assets in liquidation.
A preference share usually has a stated dividend that is expressed as a percentage of its par value. It normally does not have voting rights.
Normally has no voting rights

18. Preference Shares vs. Noncumulative Cumulative
Dividends in arrears must be paid before dividends may be paid on ordinary shares. (Normal case)
Undeclared dividends from current and prior years do not have to be paid in future years.
Consider the following Shareholders’ Equity section of the Balance Sheet. The Board of Directors did not declare or pay dividends in In 2011, the Board declared and paid cash dividends of $42,000.
Cumulative preference shareholders have the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to common shareholders. When the preference shares are cumulative and the directors do not declare a dividend to preference shareholders, the unpaid dividend is called a dividend in arrears and must be disclosed in the financial statements. Most preference shares are cumulative.
Noncumulative preference stock has no rights to prior periods’ dividends if they were not declared in those prior periods.
Let’s look at an example. This company has both ordinary shares and preference shares. The directors did not declare a dividend in In 2011, the directors declared and paid cash dividends of $42,000. Let’s see how this dividend is distributed if the preferred shares are cumulative and if it is noncumulative.

19. preference shares C2
If the preferred shares are noncumulative, the preferred shareholders have no rights to the missed dividends of the year However, they get first distribution of the dividends declared in The dividend for the preference shares in 2011 is calculated as follows: $100 par value times 9% times 1,000 shares. Since $42,000 in dividends were declared, preferred shareholders would receive the first $9,000, and the remaining $33,000 would be divided evenly among the common shareholders.
If the preferred shares are cumulative, the preferred shareholders have rights to the missed dividends of 2010 in addition to the dividends in The preferred shareholders first get a distribution of $9,000 for the missed dividends of Then they get another $9,000 for the dividend in Since $42,000 in dividends were declared, preferred shareholders would receive the first $18,000, and the remaining $24,000 would be divided evenly among the common shareholders.

20. Preference Shares vs. Nonparticipating Participating
Dividends may exceed a stated amount once common shareholders 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. (Normal case)
Reasons for Issuing Preference Shares
To raise capital without sacrificing control
To boost the return earned by ordinary shareholders through financial leverage
To appeal to investors who may believe the ordinary shares are too risky or that the expected return on common stock is too low
An additional preference for preferred stock is participation in dividends if they are declared above certain limits. This participation feature does not apply until ordinary shareholders receive dividends equal to the preferred stock’s dividend percent. This is not a common preference seen in practice.
Corporations may issue preferred stock to be able to raise needed capital without sacrificing control since preferred stock has no voting rights. Issuing preferred stock is a way to boost return to ordinary shareholders. It is also a way to increase ownership in the company if the ordinary shares is perceived as too risky or has a lower than expected return.

21. Treasury Shares
P 3
Treasury shares are a company’s own shares that have been acquired. Corporations might acquire its own shares to:
Use their shares to buy other companies.
Avoid a hostile takeover.
Reissue to employees as compensation.
Support the market price.
Corporations might acquire their own stock to:
Use their shares to buy other companies.
Avoid a hostile takeover.
Reissue to employees as compensation.
Support the market price.
As this graph indicates, the majority of corporations have some treasury stock.

22. Purchasing Treasury Shares
On May 8, Whitt, Inc. purchased 2,000 of its own shares in the open market for $4 per share.
On May 8th, Whitt Incorporated purchased 2,000 of its own shares in the market for $8,000. The entry on May 8th includes a debit to Treasury Stock and a credit to Cash for $8,000, the amount of the purchase. The Treasury Stock would be reported on the balance sheet in the equity section as a reduction from total equity.
Treasury shares are shown as a reduction in total
shareholders’ equity on the balance sheet.

23. Selling Treasury Shares at Cost
P 3
On June 30, Whitt sold 100 shares of its treasury shares for $4 per share.
On June 30th, Whitt sold 100 shares of the treasury stock for $4 dollars per share. This entry would include a debit to Cash and a credit to Treasury Stock for $400. This was a simple entry because we sold the treasury stock for its original cost of $4 per share.
Let’s see what happens when the selling price of the treasury stock is different than its cost.

24. Selling Treasury Shares Above Cost
P 3
On July 19, Whitt, Inc. sold an additional 500 treasury shares for $8 per share.
On July 19th, Whitt sold 500 shares of the treasury stock for $8 per share. Remember that the original cost of the treasury stock was $4 per share.
This entry would include a debit to Cash for $4,000. The credit to Treasury Stock is for $2,000, the original cost of $4 per share times the 500 shares sold. The difference between the selling price and the cost of the treasury stock is credited to Paid-in Capital, Treasury Stock. In this example, that amount is $2,000. Now, let’s see what happens if we sell treasury stock for less than its original cost.

25. Selling Treasury Shares Below Cost
P 3
On August 27, Whitt sold an additional 400 treasury shares for $1.50 per share.
On August 27th, Whitt sold 400 shares of the treasury stock for $1.50 per share. Remember that the original cost of the treasury stock was $4 per share.
This entry would include a debit to Cash for $600. The credit to Treasury Stock is for $1,600, the original cost of $4 per share times the The difference between the selling price and the cost of the treasury stock is debited to Paid-in Capital, Treasury Stock. In this example, that amount is $1,000.

26. Statement of Comprehensive Income
Statement of Comprehensive Income (SCI)
All non-owner changes in equity + other comprehensive income
Can be 2 statements: Income statement + SCI
The corporation must present a statement of comprehensive income which is intended to show all nonowner changes in equity and other comprehensive income. The statement of comprehensive income can be shown as a single statement. Alternatively, the statement of comprehensive income can be presented as two statements: (1) an income statement which presents revenues and expenses recognized in the calculation of profit or loss, and (2) a statement of comprehensive income which begins with the profit or loss from the income statement and then lists other items of income and expense (e.g., revaluation gains) to show total comprehensive income.

27. Statement of Changes in Equity
Statement of Changes in Equity (SCE)
All owner changes in equity, including changes in accounting policies
Dividends
The corporation must present a statement of changes in equity, which is intended to show all owner changes in equity and dividends. This statement includes the total amount of comprehensive income but its main purpose is to show the amounts of transactions with shareholders (e.g., share issues and dividends) and to provide a reconciliation of the opening and closing balance of each class of equity and each reserve. The statement of changes in equity also shows the effects of any changes in accounting policies and correction of prior period errors.

28. Reserves C3
Most reserves result from accounting standards to reflect certain measurement changes in equity rather than the income statement, e.g. asset revaluation reserve, foreign currency translation reserve and other statutory reserves.
Retained earnings also called revenue reserves.
Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends A company’s cumulative net income less any net losses and dividends declared since its inception.

29. Earnings Per Share
A 1
Earnings per share is one of the most widely cited accounting statistics.
Basic earnings
per share =
Net income - Preference dividends
Weighted-average ordinary shares outstanding
Earnings per share is one of the most widely cited accounting statistics. It is calculated as net income minus preference dividends divided by the weighted-average ordinary shares outstanding.

30. PRICE–EARNINGS RATIO Price– Earnings Ratio Market value per share
This ratio reveals information about the stock market’s expectations for a company’s future growth in earnings, dividends, and opportunities.
Price–
Earnings Ratio =
Market value per share
Earnings per share
The price-earnings ratio reveals information about the stock market’s expectation for a company’s future growth in earnings, dividends, and opportunities. It is calculated as market value per share divided by earnings per share.

31. Annual cash dividends per share
Dividend Yield
A 3
Tells us the annual amount of cash dividends distributed to ordinary shareholders relative to the share’s market price.
Dividend
Yield =
Annual cash dividends per share
Market value per share
The dividend yield ratio provides the annual amount of cash dividends distributed to ordinary shareholders relative to the stock’s market price. It is calculated as the annual cash dividend per share divided by the market value per share.

32. BOOK VALUE PER ORDINARY SHARE
Reflects the amount of shareholders’ equity applicable to ordinary shares on a per share basis.
Shareholders’ equity applicable to ordinary shares
Number of ordinary shares outstanding
Book value per ordinary share =
The book value per ordinary share reflects the amount of shareholders’ equity applicable to ordinary shares on a per share basis. It is calculated as shareholders’ equity applicable to ordinary shares divided by the number of ordinary shares outstanding.

33. End of Chapter 13
End of Chapter 13.