Corporations

Chapter 12

Corporation Characteristics

Is a legal entity, distinct and separate from the individuals who create and operate it.

It may acquire, own and dispose of property in its own name.

It may also incur liabilities and enter into contracts

It can sell shares of ownership Stock – shares of ownership It gives the corporations the ability to raise large

amounts of capital.

Corporations

Stock – shares of ownership Stockholder – owners of stock Dividends – distribution of income to

shareholders

Types of Corporations

Public Corporations those with shares of stock are traded in

public markets such as the NASDAQ or NYSE regulated by the Securities and Exchange

Commission. http://www.sec.gov/

Private or Nonpublic Corporations

Shares are not traded publicly are usually owned by a small group of investors.

Additional Characteristics

Additional Characteristics of Corporations Limited liability

A corporation’s creditors usually may not go beyond the assets of the corporation to satisfy their claims.

Board of Directors Elected by the shareholders Meets periodically to establish corporate policies Selects the Chief Executive Officers

Dividends Distribution of income to shareholders

Liable for Taxes on the income of the corporation before the distribution of dividends to shareholders may cause double taxation of income

Forming a Corporation

Application of incorporation Filed with the state authority http://www.sunbiz.org/ Once approved the state grants a Charter

or Articles of Incorporation

Articles of incorporation Formally create the corporation

Organizational Costs

Costs may be incurred in organizing a corporation

Costs include legal fees, taxes, state incorporation fees, license fees, and promotional costs

Example 1

Suppose that $15,000 is spent in the forming of the corporation.

Account Debit Credit

Organizational costs $15,000

Cash $15,000

Paid-In Capital from Issuing Stock

Two main sources of stockholders’ equity Paid in capital

Paid in capital comes from the issuance of stock

Retained earnings From the earnings of the business not

distributed as dividends

Stock

Authorized – number of shares of stock that a corporation can issue

Issued – number sold Outstanding – number in hands of

stockholders

Stock

Authorizing > Issued ≥ Outstanding

Stock

Par value or stated value – assigned monetary value

Rights Right to vote in matters concerning

the corporation Right to share in distribution of

earnings Right to share in assets at liquidation Rights vary with the class of stock

Classes of Stock

Common stock Has all the rights listed above

Preferred stock The dividend rights of preferred stock are usually

stated in monetary terms or as a percent of par $2 preferred stock

Has a right to an annual $2 per share dividend 5% preferred stock with par of $100

Has a right to an annual dividend of $5 per share

They have the first right to dividends when any dividends are declared.

Have greater chance of receiving their dividends

Dividends

Dividends First paid to

preferred stockholders

Remainder to common stockholders

Dividend Distributionsby class

Corporation has 4,000 shares of common stock and 1,000 shares outstanding of 8% preferred stock with a par value of $50. The Board declares the following dividends.

2006 2007 2008

$20,000 $50,000 $62,000

Example 2

What are dividends distributed to preferred stock and common stock?

Preferred stock gets 8% times par value 8% x $50 = $4 per share

There are 1,000 shares outstanding of preferred stock so dividend is:

$4 per share x 1,000 shares outstanding = $4,000

Example 2

2006 2007 2008

Dividends $20,000 $55,000 $62,000

Preferred stock

$4,000 $4,000 $4,000

Common Stock

$16,000 $51,000 $58,000

Note

Even though the dividends declared increased each year, preferred stock only received the $4,000 and common stock always receives the remainder which increases as dividends increase.

Example 3

Corporation has 5,000 shares of common stock and 2,000 shares outstanding of $10 preferred stock with a par value of $50. The Board declares the following dividends.

2005: $30,0002006: $55,0002007: $20,000What are dividends distributed to

preferred stock and common stock?

Issuing Stock

An account is created for each type of stock.

These accounts are classified as equity. They increase with a credit. Stock can be issued at par or above par

Issued at par: Amount received is the same amount credited to

the stock account.

Journal Entry

Account Debit Credit

Cash Amount received

Preferred stock Par value

Common stock Par value

Example 4

The Corporation issues 10,000 shares of $5 par value common stock and 4,000 shares of $10 par value preferred stock at par. Record the entry.

Preferred stock: 4,000 shares x $10 per share = $40,000Common stock: 10,000 shares x $ 5 per share = $50,000 Total cash received $90,000

Example 4

Account Debit Credit

Cash $90,000

Preferred stock $40,000

Common stock $50,000

Premium on sale of stock

When stock is issued for a price that is more than its par.

Caused by Financial conditions, earnings record,

and dividend record of the corporation

Investor expectations of the corporation’s potential earning power

Premium on sale of stock

When stock is issued for a price above its par value, it has sold at a PREMIUM.

When stock is issued for a price above its par value, it has sold at a DISCOUNT.

Difference between par value and selling price is placed in an equity account called Paid in Capital in Excess of Par.

Journal Entry

Account Debit Credit

Cash Total cash received

Preferred stock Par value

Paid in capital in excess of par

Cash - par

Example 5

The Corporation issues 4,000 shares of $10 par value preferred stock for $15 per share. Record the entry.

Preferred stock: Selling price:

$15 per share x 4,000 shares = $60,000 Par value: $10 per share x 4,000 shares =

$40,000Paid in capital $20,000 EXCESS

Journal Entry

Account Debit Credit

Cash $60,000

Preferred stock $40,000

Paid in capital in excess of par

$20,000

Example 6

The Corporation issues 7,000 shares of $4 par value common stock and 3,000 shares of $20 par value preferred stock. The common stock is issued at $7 per share and the preferred stock at $24 per share. Record the entry.

Rule

Companies will never declare a gain or loss on transactions with its own stock.

Always the difference will go to paid in capital in excess of par.

No Par Stock

Stock may be issued without par value

Entire proceeds from the sale are credited to the stock account

No paid in capital in excess of par account will exist

Accounting for Dividends

Cash dividends A cash distribution of earnings by a

corporation to its shareholders. These are the most common though other

assets may be distributed. Three conditions for dividends to be paid:

Sufficient retained earnings Sufficient cash Formal action by the board of directors. Though

they are not legally required to do so.

Three important dates with dividends:

Example 6: On May 10, 2007, the ABC

Corporation’s Board of Directors declared a cash dividend of $.25 per common stock share to stockholder’s of record on May 31, 2007 payable on June 10th. There are 10,000 shares outstanding.

Date 1: Declaration Date

Declaration date The date that Board of Directors

approves the dividend. A liability is incurred by the

corporation. Entry:

Cash dividends DR Dividends payable CR

Example 6

Date Account DR CR

May 10, 2007

Cash dividends $2500.00

Dividends Payable $2500.00

Date 2: Date of Record

This date determines which shareholders will get the dividend.

No entry Shares sold after May 31 are called

ex-dividend stock. The sales price includes a share of the dividend

Example 6

May 31 is the date of record. Shareholders at the close of business on this day will receive the dividend check.

Date 3: Payment Date

This is the date that the dividend checks are mailed out

Entry: Dividends payable DR Cash CR

Example 6

Date Account DR CR

June 10, 2007

Dividends payable $2500.00

Cash $2500.00

Stock Dividends

A distribution of shares of stock to stockholders. These distributions are in common stock Issued to holders of common stock only The effect of the stock dividend on the

stockholders’ equity of the issuing corporation is to transfer retained earnings to paid in capital. Therefore no assets are affective

The amount transferred from retained earnings to paid in capital is normally the fair market value of the shares issued in the stock dividend.

Example 7

Suppose that on June 10, 2007, Morton Company declares a 2% stock dividend on shares outstanding on June 30, 2007. The stock dividend is payable on July15, 2007. The stockholder’s equity account looks like this:

Example 7

Common stock, ($15 par value with 100,000 shares issued) $1,500,000

Paid in Capital $ 700,000Retained Earnings $7,000,000

Fair market value of stock on declaration date is $20 per share.

Example 7: Declaration Date

Date Account DR CR

June 10, 2007

Stock Dividends $40,000

Stock Dividends Distributable

$30,000

Paid in capital in excess of par

$10,000

Example 7: Payment Date

Date Account DR CR

June 10, 2007

Stock Dividends $40,000

Stock Dividends Distributable

$30,000

Paid in capital in excess of par

$10,000

Note

It does not change the assets, liabilities or total stockholder’s equity of a company

Treasury Stock

Companies may buy its own stock to provide shares: for resale to employees for reissuing as a bonus to employees for supporting the market price of the stock

Cost method A commonly used method of accounting for

the purchase and resale of treasury stock.

Treasury Stock

Transactions for Treasury Stock Repurchase –

when a company buys back its stock create a new equity account called:

Treasury Stock it is a contra equity account increases with a debit

recorded at the purchase price called COST

Treasury Stock

Sale Recorded at original buy back cost Difference between SELLING PRICE and

cost Recorded in PAID IN CAPITAL

Example 9:

A corporation has common stock with a par value of $25. The company repurchases 2,000 shares at $45 per share. Record the buy back.

Date Account DR CR

Cash $90,000

Treasury Stock $90,000

Example 9

The company sells 700 shares at $60 per share. Record the entry.

Selling price: 700 x $60 = $42,000Cost: 700 x$45 = $31,500 Excess paid in capital 10,500

Example 9

Account Debit Credit

Cash $42,000

Treasury Stock $31,500

Paid in capital in excess of par $10,500

Example 9

Selling price: 200 x $40 = $8,000Cost: 200 x$45 = $9,000 Excess paid in capital (1,000)

The company sells 200 shares at $40 per share. Record the entry.

Example 9

Account Debit Credit

Cash $8,000

Paid in capital in excess of par

$1,000

Treasury Stock $9,000

Example 10

A corporation has common stock with a par value of $10.

The company repurchases 1,000 shares at $20 per share. Record the buy back.

The company sells 500 shares at $30 per share. Record the entry.

The company sells 200 shares at $15 per share. Record the entry.

Why Paid in Capital and not a gain or loss?

Companies will never declare a gain or loss on transactions with its own stock. Always the difference will go to paid in capital in excess of par.