Ch.19 Corporate Accounting: Formation and Paid-In Capital

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Corporate Form of Business

Paid-in Capital and Earned Capital

Classification of Capital Stock

Issuance of Capital Stock

Stockholders’ Equity

Reacquisition of Capital Stock

The Corporation

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A form of business that is owned by investors (AKA stockholders or shareholders)

The investments held by stockholders are referred to as the capital stock

Publicly held Corporation: a large corporation owned by many stockholders

Closely held Corporation: a corporation owned by a small group of stockholders or a family

Advantages of the Corporate Form

Limited liability of owners Ease of raising capital Continuity of life Ease of transferring ownership No mutual agency Professional management

Disadvantages of the Corporate Form

Additional taxation Increase government regulation

• The incorporators agree to a set of bylaws, which act as the corporation’s constitution.

• The incorporators hold a meeting of stockholders and elect a board of directors.

Forming a Corporation• The incorporators must file an application with the

appropriate official in the state in which the business will be incorporated. The application is referred to as the articles of incorporation.

• The state grants the incorporators a charter. Charter: a contract between the state and the incorporators authorizing the corporation to conduct business.

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Organization Costs

• Costs associated with forming a corporation

Attorneys’ fees

State charter fees

License fees

Cost of printing the stock certificates

Promotions costs

• Incurred before the corporation actually begins operations

• Expensed when incurred

• Assume Lori Hume incurred $4,500 of organizational costs on Jun. 25, 20X4. The following entry is prepared:

20X4

June25 Organization Costs 4,500

Cash 4,500

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Used to record earnings in the past periods that have not been distributed to stockholders

Used to record sales of the company’s stock

• The owner’s equity in a corporation • Represents the excess of total assets over total liabilities• Is divided into paid-in capital and earned capital

o Paid-in capital comes from the stockholders thru the purchase of the company’s stock.

o Earned capital arises from profitable operations and is referred to as retained earnings.

Paid-in capital and earned capital

Capital Stock• The general term used to describe the shares of ownership in a

corporation• Authorized Stock: the maximum number of shares the corporation is

permitted to sell • Issued Stock: shares that have been sold to stockholders• The number of shares issued may not be more than the number of

shares authorized• On occasion, a corporation may buy back some of the shares that were

issued at an earlier date• These reacquired shares are held in the corporate treasury and are

referred to as treasury stock• Treasury shares are still considered to be issued, but they are not

considered to be outstanding

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• Outstanding Stock The difference between the number of shares issued and the number

of treasury shares The number of shares actually in the hands of the stockholders

Stock Trading Diagram

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Common Stock

• The stock issued if a corporation issues only one type of stock• The basic rights and privileges of common stockholders

The right to share in distribution of earnings when declared by the board of directors

The right to vote The right to maintain their proportionate ownership share of the

corporation if the corporation issues additional shares of stock, called the preemptive right

The right to share in the final distribution of assets if the corporation is liquidated

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Preferred Stock• The type of stock issued when a corporation issues a class of stock in

addition to common• Preferred stock has preference over common stock in two ways:

A prior claim to dividends when declared by the board of directors A prior claim to assets should the corporation find it necessary to

liquidate

Cumulative and Noncumulative Preferred Stock

• Corporations are under no legal obligation to pay a dividend to stockholders.

• When a dividend isn’t declared by a corporation, it is said to be passed.

• Cumulative Preferred Stock retains rights to passed dividends.

• These unpaid dividends, called dividends in arrears, must be paid in full before any dividend is paid to common stockholders.

• If stockholders own noncumulative preferred stock, their passed dividends do not accumulate.

• Most preferred stock is cumulative.9

Participating and Nonparticipating Preferred Stock

• Preferred stock usually has a stated or fixed dividend rate.

• Some preferred stock is allowed to receive dividends in excess of a fixed amount, and is referred to as participating preferred stock.

• Holders of participating preferred stock first get their regular dividend.

• If an amount is left after the common stockholders receive a dividend, the preferred stockholders can participate with the common stockholders in the extra dividend.

• Most preferred stock is nonparticipating.

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Issuing Capital Stock• Par Value Stock: stock for which a fixed dollar amount is designated in

the corporate charter as the value of each share• No-par Value Stock: stock without a fixed dollar amount assigned to

each share• Stated Value Stock: no-par stock with a value assigned to it• There is little difference between accounting for par value stock and

for stated value stock

Selling Stock at Par Value for Cash• Example: On Jan. 15, 20X1, Ace Trucking, Inc., issued 2,000 shares of

preferred stock and 10,000 shares of common stock at par for cash. The preferred stock has a par value of $100 and the common stock has a par value of $10.

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20X1Jan.

15 Cash 300,000

Preferred Stock 200,000

Common Stock 100,000

Issuing Stock at Par Value for Noncash Assets• On Jan. 18, 20X1, Ace Trucking, Inc., issued 500 shares of common stock at

par to an attorney for services received in obtaining the corporation

charter. The common stock has a par value of $10. Ace records the

following journal entry:

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20X1Jan.

18 Organization Costs 5,000

Common Stock 5,000

Selling Stock Above Par Value for Cash• When the market price of stock exceeds its par value, the stock is

said to sell for a premium

• Premium: the amount by which the issue price exceeds the par value

On May 15, 20X1, Ace Trucking, Inc., issued 500 shares of preferred stock at

$102 per share. The preferred stock has a par value of $100. Ace records the

following journal entry:

20X1May

15 Cash 51,000

Preferred 50,000

Paid-in Capital In Excess of Par-Preferred 1,000

Issuing Stock Above Par Value in Exchange for Noncash Assets

When noncash assets are received in exchange for capital stock,

the assets acquired should be recorded at their fair market value.

• Assume on Jun. 20, 20X1, Ace Trucking, Inc. issued 5,000 shares

of common stock and accepted land and a building.

• The land has a fair market value of $10,000 and the building has a

fair market value of $70,000.

• The common stock has a par value of $10. Ace records the

following journal entry:

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20X1Jun.

20 Land 10,000

Building 70,000

Common Stock 50,000

Paid-in Capital InExcess of Par-Common

30,000

Issuing Stock Below Par Value

• If stock is sold for an amount below its par value, the stock is said to sell at a discount.

• The issuance of stock below par value is very rare and is not allowed in many states.

• On Oct. 15, 20X0, Binker, Inc. issues 500 shares of $10 par common stock for $8 per share. Binker records the following journal entry:

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20X0

Oct.15 Cash 4,000

Discount on Common Stock 1,000

Common Stock 5,000

Stockholders’ Equity Section of the Balance Sheet• Using all the transactions recorded for Ace Trucking, Inc., we can prepare

the Stockholders’ Equity section of the balance sheet.

• Assume on the date of the balance sheet, Ace Trucking has a $40,000

credit balance in its Retained Earnings account.

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To this point, the total capital invested

in the company is $556,000.

Issuing No-Par Value Stock

• On Mar. 23, 20X8, Sterling Corporation issues 5,000 shares of no-par

common stock for $50 per share. Sterling records the following journal

entry:

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20X8Mar.

23 Cash 250,000

Common Stock 250,000

Issuing Stated Value Stock• No-par stock is sometimes issued with a stated value.

• The stated value of the shares outstanding then becomes the legal capital

of the corporation.

On Dec. 18, 20X1, Buker Corporation issued 300 shares of $15 stated value stock

for $17 a share. Buker records the following journal entry:

20X1Dec.

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Cash 5,100

Common Stock 4,500

Paid-in Capital InExcess of Stated Value

600

Stock Subscriptions

• Corporations may sell stock on a subscription, or installment, basis.

• The company enters into a contract with a subscriber to purchase a specified number of shares at a specified price.

• The shares will be issued only when the full contract price has been received from the subscriber.

• The subscription price is debited to an asset account entitled Subscriptions Receivable.

• The par value of the subscribed shares is credited to an equity account entitled Stock Subscribed.

• On Jun. 1, 20X1, Ace Trucking enters into a stock subscription plan for 20,000 shares of $10 par common stock at $12 per share. Ace will receive three equal installments on June 1, July 1 and August 1. Ace records the following journal entries:

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20X1

Jun.1 Subscriptions Receivable 240,000

Common Stock Subscribed 200,000

Paid-in Capital in Excess of

Par-Common40,000

Jun. 1 Cash 80,000

Subscriptions Receivable 80,000

Jul. 1 Cash 80,000

Subscriptions Receivable 80,000

Aug. 1 Cash 80,000

Subscriptions Receivable 80,000

Aug. 1 Common Stock Subscribed 200,000

Common Stock 200,000

Treasury Stock

• The issued shares the corporation buys back from stockholders.

• Is like unissued stock in that it has no voting rights, no dividend rights, and no right to share in assets if the corporation liquidates.

• A corporation cannot buy its own unissued stock, nor can a corporation own part of itself.

• A corporation can buy back from stockholders issued shares of stock.

• We use the cost method to account for the purchase of treasury stock and ignore the original selling price of the stock.

• Assume on Jan. 4, 20X2, Ace Trucking, Inc. buys back 1,000 shares of its common stock for $15 per share. The common stock had a par value of $10 per share. On Mar. 15, 20X2, Ace sold 500 shares of the treasury stock for $20 each. On Apr. 28, 20X2, Ace sold 200 shares of treasury stock for $14 each.

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20X2

Jan.4 Treasury Stock 15,000

Cash 15,000

Mar. 15 Cash 10,000

Treasury Stock 7,500

Paid-in Capital from Sale of

Treasury Stock2,500

Apr. 28 Cash 2,800

Paid-in Capital from Sale of Treasury

Stock200

Treasury Stock 3,000

Reporting Treasury Stock on the Balance Sheet• The balance of Paid-in Capital from Sale of Treasury Stock is

reported in the Paid-in Capital section of the balance sheet.

• The balance of the Treasury Stock account is deducted from the

total of the paid-in capital and retained earnings.

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Controlling Account Subsidiary Ledger

Common Stock Common Stockholders’ Ledger

Preferred Stock Preferred Stockholders’ Ledger

Subscriptions Receivable Subscribers’ Ledger

Controlling Accounts and Subsidiary Ledgers

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