11-1. 11-2 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings Learning Objectives After studying this chapter,

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Chapter 11

Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings

Learning Objectives

After studying this chapter, you should be able to:

1. Identify the major characteristics of a corporation.

2. Record the issuance of common stock.

3. Explain the accounting for treasury stock.

4. Differentiate preferred stock from common stock.

5. Prepare the entries for cash dividends and stock dividends.

6. Identify the items reported in a retained earnings statement.

7. Prepare and analyze a comprehensive stockholders’ equity section.

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Preview of Chapter 11

Financial and Managerial Accounting

Weygandt Kimmel Kieso

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An entity separate and distinct from its owners.

Classified by Purpose

Not-for-Profit

For Profit

Classified by Ownership

Publicly held

Privately held

► McDonald’s► Nike► PepsiCo► Google

► Salvation Army► American Cancer

Society

► Cargill Inc.

The Corporate Form of Organization

LO 1 Identify the major characteristics of a corporation.

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Separate Legal Existence

Limited Liability of Stockholders

Transferable Ownership Rights

Ability to Acquire Capital

Continuous Life

Government Regulations

Additional Taxes

Corporate Management

Characteristics that distinguish corporations from

proprietorships and partnerships.


Advantages

Disadvantages

Characteristics of a Organization

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Continuous Life


Additional Taxes



Corporation acts under its own name rather than in the name of its stockholders.




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Continuous Life


Additional Taxes



Limited to their investment.




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Continuous Life


Additional Taxes



Shareholders may sell their stock.




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Continuous Life


Additional Taxes



Corporation can obtain capital through the issuance of stock.




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Continuous Life


Additional Taxes



Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer.




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Continuous Life


Additional Taxes






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Continuous Life


Additional Taxes



Corporations pay income taxes as a separate legal entity and in addition, stockholders pay taxes on cash dividends.




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Continuous Life


Additional Taxes



Separation of ownership and management prevents owners from having an active role in managing the company.




11-14 LO 1 Identify the major characteristics of a corporation.

Stockholders

Chairman and Board of Directors

President andChief Executive

Officer

General Counsel and

Secretary

Vice PresidentMarketing

Vice PresidentFinance/Chief

Financial Officer

Vice PresidentOperations

Vice PresidentHuman

Resources

Treasurer Controller

Illustration 11-1 Corporation organization chart


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Formed by grant of a state charter.

Corporation develops by-laws.

Initial Steps:


Companies generally incorporate in a state whose laws are

favorable to the corporate form of business (Delaware, New

Jersey).

Corporations expense organization costs as incurred.

Forming a Corporation

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1. Vote in election of board of directors and on actions that require stockholder approval.

Stockholders have the right to:


2. Share the corporate earnings through receipt of dividends.

Illustration 11-3

Ownership Rights of Stockholders

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3. Keep the same percentage ownership when new shares of stock are issued (preemptive right*).


* A number of companies have eliminated the preemptive right.

Illustration 11-3



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4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim.


Illustration 11-3



11-20 LO 1

Class A COMMON STOCK

Class A COMMON STOCK

PAR VALUE $1 PER SHARE

PAR VALUE $1 PER SHARE

Stock CertificateStock Certificate

Name of corporation

Stockholder’s name

Class

Shares

Signature of corporate official

PrenumberedIllustration 11-4



Charter indicates the amount of stock that a corporation

is authorized to sell.

Number of authorized shares is often reported in the

stockholders’ equity section.

Authorized Stock

Stock Issue Considerations


Corporation can issue common stock directly to investors

or indirectly through an investment banking firm.

Factors in setting price for a new issue of stock:

1. Company’s anticipated future earnings.

2. Expected dividend rate per share.

3. Current financial position.

4. Current state of the economy.

5. Current state of the securities market.

Issuance 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.

Market Value of Stock


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Years ago, par value determined the legal capital per

share that a company must retain in the business for the

protection of corporate creditors.

Today many states do not require a par value.

No-par value stock is quite common today.

In many states the board of directors assigns a stated

value to no-par shares.

Par and No-Par Value Stock


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Paid-in CapitalPaid-in CapitalPaid-in CapitalPaid-in Capital

Retained EarningsRetained EarningsAccountAccount


Paid-in Capital in Paid-in Capital in Excess of ParExcess of Par

AccountAccount


AccountAccount

Two Primary Sources of

Equity

Common StockCommon StockAccountAccount


Preferred StockPreferred StockAccountAccount


Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock.

Corporate Capital


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Equity





Retained earnings is net income that a corporation retains for future use.

Corporate Capital



AccountAccount


AccountAccount

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Comparison of the owners’ equity (stockholders’ equity)

accounts reported on a balance sheet for a proprietorship,

and a corporation.

Illustration 11-6

Corporate Capital


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Primary objectives:

1) Identify the specific sources of paid-in capital.

2) Maintain the distinction between paid-in capital and

retained earnings.

LO 2 Record the issuance of common stock.

Other than consideration received, the issuance

of common stock affects only paid-in capital

accounts.

Accounting for Common Stock Issues

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Illustration: Assume that Hydro-Slide, Inc. issues 2,000 shares of $1 par value common stock. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000 shares are issued for $5 per share.

Cash 1,000

Common stock (1,000 x $1)

1,000Cash 5,000

Common stock (1,000 x $1)

1,000Paid-in capital in excess of par value

4,000

a)

b)



Issuing Par Value Common Stock for Cash

11-32 LO 2 Record the issuance of common stock.

Illustration 11-7


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Illustration: 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.

Cash 40,000

Common stock

25,000

Paid-in capital in excess of stated value

15,000



Issuing No-Par Common Stock for Cash

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Illustration: What happens when no-par stock does not have a stated value?

Cash 40,000

Common stock

40,000



Issuing No-Par Common Stock for Cash

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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.


Issuing Common Stock for Services or Noncash Assets

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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



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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



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Total take: $1.7 million

ANATOMY OF A FRAUD

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.

The Missing Control

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.

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AccountAccount


AccountAccount

Less:Less:Treasury StockTreasury Stock

Account

Less:Less:Treasury StockTreasury Stock

Account


Equity





LO 3 Explain the accounting for treasury stock.

Accounting for Treasury Stock

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Treasury stock - corporation’s own stock that it has

reacquired from shareholders, but not retired.

Corporations purchase their outstanding stock:

1. To reissue the shares to officers and employees under

bonus and stock compensation plans.

2. To enhance the stock’s market value.

3. To have additional shares available for use in the acquisition

of other companies.

4. To increase earnings per share.



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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.



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Treasury stock (4,000 x $8) 32,000

Cash 32,000

Illustration: On February 1, 2014, Mead acquires 4,000 shares of its stock at $8 per share.


Illustration 11-8


11-43 LO 3 Explain the accounting for treasury stock.

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.

Illustration 11-9


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Sale of Treasury Stock

Above Cost

Below Cost

Both increase total assets and stockholders’ equity.



Disposal of Treasury Stock

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Treasury stock

8,000

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

Paid-in capital treasury stock

2,000

Cash 10,000

A corporation does not realize a gain or suffer a loss from stock transactions with its own stockholders.

Accounting for Treasury Stock Above Cost

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Paid-in capital treasury stock 800

Illustration: On Oct. 1, Mead sells an additional 800 shares of

treasury stock at $7 per share.


Oct. 1

Treasury stock

6,400

Cash 5,600

Accounting for Treasury Stock Below Cost

Illustration 11-10

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Paid-in capital treasury stock 1,200

Illustration: On Dec. 1, assume that Mead, Inc. sells its

remaining 2,200 shares at $7 per share.


Dec. 1

Retained earnings 1,000

Cash 15,400

Treasury stock

17,600

Limited to

balance on hand

Accounting for Treasury Stock Below Cost

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Features often associated with preferred stock.

1. Preference as to dividends.

2. Preference as to assets in liquidation.

3. Nonvoting.

LO 4 Differentiate preferred stock from common stock.

Accounting for preferred stock at issuance is similar to that for common stock.

Accounting for Preferred Stock

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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)

100,000Paid-in capital in excess of par –

Preferred stock

20,000

Preferred stock may have a par value or no-par value.


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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.



Dividend Preferences

11-52 LO 4 Differentiate preferred stock from common 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.

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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.



Liquidation Preferences

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Distribution of cash or stock to stockholders on a pro rata

(proportional) basis.

Types of Dividends:

LO 5 Prepare the entries for cash dividends and stock dividends.

1. Cash dividends.

2. Property dividends.

Dividends expressed: (1) as a percentage of the par or stated

value, or (2) as a dollar amount per share.

3. Stock dividends.

4. Scrip.

Dividends

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Three dates:


Dividends

Illustration 11-12

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For a corporation to pay a cash dividend, it must have:

1. Retained earnings - Payment of cash dividends from

retained earnings is legal in all states.

2. Adequate cash.

3. A declaration of dividends by the Board of Directors.


Dividends

Cash Dividends

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Illustration: On Dec. 1, the directors of Media General declare a 50¢ per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is payable on Jan. 20 to shareholders of record on Dec. 22.

December 1 (Declaration Date)

Cash dividends 50,000

Dividends payable 50,000

December 22 (Date of Record)

January 20 (Payment Date)



Cash 50,000

No entry

Cash Dividends

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Allocating Cash Dividends Between Preferred and Common Stock


Holders of cumulative preferred stock must be paid any

unpaid prior-year dividends before common stockholders

receive dividends.

Dividends

11-59 LO 5 Prepare the entries for cash dividends and stock dividends.

Illustration: On December 31, 2014, IBR Inc. has 1,000 shares of 8%, $100 par value cumulative preferred stock. It also has 50,000 shares of $10 par value common stock outstanding. At December 31, 2014, the directors declare a $6,000 cash dividend. Prepare the entry to record the declaration of the dividend.



Pfd Dividends: 1,000 shares x $100 par x 8% = $8,000

Dividends


2012 2013

Dividends declared 6,000$

Dividends in arrears

Allocation to preferred 6,000

Remainder to common -$

* 1,000 shares x $100 par x 8% = $8,000

*

** 2012 Pfd. dividends $8,000 – declared $6,000 = $2,000

**

Illustration: At December 31, 2015, IBR declares a $50,000 cash dividend. Show the allocation of dividends to each class of stock.

$ 50,000

2,000

8,000

$ 40,000

Dividends



Dividends payable

50,000

Illustration: At December 31, 2015, IBR declares a $50,000 cash dividend. Prepare the entry to record the declaration of the dividend.

Dividends

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Results in decrease in retained earnings and increase in paid-in capital.

Illustration 11-14

Dividends

Stock Dividends

Pro rata distribution of the corporation’s own stock.

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Reasons why corporations issue stock dividends:

1. Satisfy stockholders’ dividend expectations without

spending cash.

2. Increase marketability of the corporation’s stock.

3. Emphasize a portion of stockholders’ equity has been

permanently reinvested in the business.


Dividends

Stock Dividends

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Small stock dividend (less than 20–25% of the corporation’s issued stock, recorded at fair market value)

Large stock dividend (greater than 20–25% of issued stock, recorded at par value)


* Accounting based on the assumption that a small stock dividend will have little effect on the market price of the outstanding shares.

*

Dividends

Stock Dividends

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10% stock dividend is declared

Stock dividends (50,000 x 10% x $15) 75,000Common stock dividends distributable 50,000Paid-in capital in excess of par value 25,000

Stock issued

Common stock dividends distributable 50,000Common stock (50,000 x 10% x $1) 50,000

Illustration: Medland Corporation has a balance of $300,000 in retained earnings. It declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair market value of its stock is $15 per share.


Dividends

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Stockholders’ Equity with Dividends Distributable


Dividends

Illustration 11-15Statement presentation of common stock dividends distributable

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Medland Corporation Before After NetDividend Dividend Change

Stockholders' equityPaid-in capital

Common stock, $10 par 500,000$ 550,000$ 50,000$ Paid-in capital in excess of par - 25,000 25,000

Retained earnings 300,000 225,000 (75,000) Total stockholders' equity 800,000$ 800,000$ -$

Outstanding shares 50,000 55,000 Par value per share 10$ 10$


Effects of Stock Dividends

Dividends

Illustration 11-16

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Which of the following statements about small stock dividends is true?

a. A debit to Stock Dividends for the par value of the shares issued should be made.

b. A small stock dividend decreases total stockholders’ equity.

c. Market value per share should be assigned to the dividend shares.

d. A small stock dividend ordinarily will have no effect on book value per share of stock.

Question


Dividends

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In the stockholders’ equity section, Common Stock Dividends

Distributable is reported as a(n):

a. deduction from total paid-in capital and retained

earnings.

b. current liability.

c. deduction from retained earnings.

d. addition to capital stock.


Dividends

Question


Dividends

Reduces the market value of shares.

No entry recorded for a stock split.

Decrease par value and increase number of shares.

Stock Split


Effects of Stock Splits

Dividends

Medland Corporation Before After NetSplit Split Change

Stockholders' equityPaid-in capital

Common stock 500,000$ 500,000$ -$ Paid-in capital in excess of par - - -

Retained earnings 300,000 300,000 - Total stockholders' equity 800,000$ 800,000$ -$

Outstanding shares 50,000 100,000 Par value per share 10$ 5$

Illustration 11-17

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Net income increases Retained Earnings and a net loss

decreases Retained Earnings.

Part of the stockholders’ claim on the total assets of the

corporation.

Debit balance in Retained Earnings is identified as a

deficit.

LO 6 Identify the items reported in a retained earnings statement.

Retained Earnings

Illustration 11-20

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Restrictions can result from:

1. Legal restrictions.

2. Contractual restrictions.

3. Voluntary restrictions.


Companies generally disclose retained earnings restrictions in

the notes to the financial statements.

Retained Earnings Restrictions

Retained Earnings

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Correction of an error in previously issued financial

statements.

Result from:

► mathematical mistakes.

► mistakes in application of accounting principles.

► oversight or misuse of facts.

Adjustment made to the beginning balance of retained

earnings.


Prior Period Adjustments

Retained Earnings

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Balance, January 1 1,050,000$ Net income 360,000 Dividends (300,000) Balance, December 31 1,110,000$

For the Year Ended December 31, 2014Statement of Retained Earnings

Woods, Inc.

Before issuing the report for the year ended December 31, 2014, you discover a $50,000 error (net of tax) that caused the 2013 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2013. Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2014?


Retained Earnings Statement

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Balance, January 1, as previously reported 1,050,000$ Prior period adjustment - error correction (50,000) Balance, January 1, as restated 1,000,000 Net income 360,000 Dividends (300,000) Balance, December 31 1,060,000$

For the Year Ended December 31, 2014Statement of Retained Earnings

Woods, Inc.



11-79 LO 6 Identify the items reported in a retained earnings statement.

Debits and Credits to Retained Earnings

Illustration 11-24


11-80

All but one of the following is reported in a retained

earnings statement. The exception is:

a. cash and stock dividends.

b. net income and net loss.

c. some disposals of treasury stock below cost.

d. sales of treasury stock above cost.

Question



11-81 LO 7

Illustration 11-26

Statement Presentation and Analysis

Presentation

Note R: Retained earnings is restricted for the cost of treasury stock, $80,000.

11-82

Net Income Available to Common Stockholders

Return on Common

Stockholders’ Equity

=

Average Common Stockholders’ Equity

LO 7 Prepare and analyze a comprehensive stockholders’ equity section.

Ratio shows how many dollars of net income the company

earned for each dollar invested by the stockholders.

Statement Presentation and Analysis

Analysis

Documents

11-1. 11-2 Chapter 11 Corporations: Organization, Stock Transactions, Dividends, and Retained Earnings Learning Objectives After studying this chapter,