CHAPTER TWENTY-TWO CORPORATIONS: ORGANIZATIONS AND CAPITAL STOCK

CHAPTER TWENTY-TWO

CORPORATIONS: ORGANIZATIONS AND

CAPITAL STOCK

CORPORATIONS

Sell more goods and services in total than sole proprietorships and partnerships combinedBut there are fewer businesses organized as

corporations. Separate legal entity that exists separate from

its ownersCorporation’s assets and liabilities are those of the

business, not the owners.Corporation can own property, enter into contracts and

incur debt in its own name. It can sue and be sued.

CHARACTERISTICS

LIMITED LIABILITY OF OWNERSOwners of a corporation generally have no personal liability for the debts of the corporation.

Major advantageof corporations

CHARACTERISTICS

TRANSFERABLE OWNERSHIP UNITS

Owner’s equity in a corporation is called Capital Stock. Capital Stock is divided into shares that can be transferred from one person to another without the consent of the other owners and without disturbing the corporation’s normal activities.

CHARACTERISTICS

EASE OF RAISING CAPITAL

The limited liability and transferable ownership characteristics are attractive to investors. Therefore, a corporation generally can obtain capital by selling additional shares of stock.

CHARACTERISTICS

NO MUTUAL AGENCY

Unlike partnerships, in a corporation individual owner’s do not have the power to act as an agent of the business.

CHARACTERISTICS

UNLIMITED LIFE

The corporation’s charter states the life as either perpetual or renewable. Changes in ownership have no effect on the life of a corporation.

CHARACTERISTICS

TAXATION OF EARNINGS

Corporations must pay income taxes. In addition, the corporation’s owners pay personal income tax on the dividends they receive. This results in “Double taxation”.

DISADVANTAGE

CHARACTERISTICS

GOVERNMENT REGULATION

Activities of the corporation are regulated by federal, state and local laws. These laws may restrict the corporation’s ownership of real property, the purchase of its own stock and the retention of its earnings.

DISADVANTAGE

CORPORATION States have the power to create corporations.

• Incorporators file an application with the state.

• Once application is approved...Charter, also called Certificate of Incorporation, is prepared, including:

- Name of the corporation

- Location of the principal office

- Purpose of the business

-Description of the capital stock

-Names and addresses of the incorporators

TERMINOLOGY

BYLAWS - provide general guidelines for conducting the business

STOCKHOLDERS - owners in a corporation STOCK CERTIFICATE - form that shows the name of

stockholder and number of shares owned BOARD OF DIRECTORS - elected by stockholders,

determine corporate policies OFFICERS - manage the corporation and are responsible

to the board

CORPORATE ORGANIZATION

OWNERS(Stockholders)

Who elect the Who Appoint the

OFFICERS (President,Vice President, Secretary,

Treasurer)

Who Manage the EMPLOYEES

BOARD OFDIRECTORS

ORGANIZATION COSTS

IncorporationFees

AttorneyFees

PromotionExpenses

EXAMPLES:

ORGANIZATION COSTSEXAMPLE: Neo Company charged $8,000 to Organization Costs (an Intangible Asset). These costs will be written off over a five-year period.

Organization Costs5 years

It is the accepted practiceto amortize Organization Costs

over a 5 year period.

ORGANIZATION COSTSEXAMPLE: Neo Company charged $8,000 to Organization Costs (an Intangible Asset). These costs would be written off over a five-year period.

Organization Costs5 years

$1,600 each year

$8,0005 years

GENERAL JOURNALDATE DESCRIPTION PR DEBIT CREDIT

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Amortization of Org. Costs 1,6001,600Organization Costs

Reported under “Other Expenses”on the Income Statement

EQUITY ACCOUNTS

SOLE PROPRIETORSHIP Owner’s EquityOwner, Capital Owner, Drawing

Two Owner’s Equity accounts

EQUITY ACCOUNTS

SOLE PROPRIETORSHIP Owner’s EquityOwner, Capital Owner, Drawing

All Equity transactions eventuallyaffect the one capital account.

1. Investments2. Net Income

2. Net Loss 3. Drawing4. Closing4. Closing

EQUITY ACCOUNTS

PARTNERSHIP Partners’ EquityPartner A, Capital Partner A, Drawing

1. Investments2. Net Income

2. Net Loss 3. Drawing4. Closing4. Closing

Partner B, Capital1. Investments2. Net Income

2. Net Loss4. Closing

Partner B, Drawing3. Drawing

4. Closing

Similar to sole proprietorshipbut multiple capital and drawing accounts

EQUITY ACCOUNTS

CORPORATION Stockholders’ EquityCapital Stock

Additional Paid-In-Capital

1. Investments

1. Investments

Only recordsinvestments by owners

EQUITY ACCOUNTS



1. InvestmentsRetained Earnings

1. Investments

Separate account whichrecords the earningsof the corporation

2. Net Income2. Net Loss

EQUITY ACCOUNTS




1. Investments

Corporations make a distinction betweencapital invested by the owners (Paid-In-Capital)

and earnings retained in the business.

2. Net Income2. Net Loss

EQUITY ACCOUNTS




1. InvestmentsDividends

Drawings are now Dividends andare closed to Retained Earnings.

2. Net Income2. Net Loss4. Closing

4. Closing3. Dividends

CAPITAL STOCK AUTHORIZED STOCK - The total number of shares the

corporate charter authorizes a corporation to issue ISSUED STOCK - Stock that has been sold and issued TREASURY STOCK - Stock that has been bought back OUTSTANDING STOCK - Number of shares in the

hands of stockholders.

STOCK VALUES

PAR VALUEDollar amount

per shareRecorded in the Capital

Stock account

MARKET VALUEAmount for which

the stock can be sold

NO-PAR STOCKStock that has no

dollar amount

Amount assigned by board of

directors

STATED VALUE

COMMON STOCK

If corporation has only one type of stock…it’s called “Common Stock.”

Gives its owner the right to:Vote at stockholder meetingsShare in earnings distributionsPurchase additional shares in proportion to the

owner’s present holding if more shares are issued

• called the “Preemptive Right”Share in the assets if the corporation liquidates

PREFERRED STOCK

Type of stock that gives its owners certain rights and privileges superior to those of common stock:for example….right to receive dividends before

common stockdividends are stated as a dollar amount or a % of

par value Don’t have common stockholders’ rights

for example... they don’t have the right to vote

DIVIDEND ALLOCATIONEXAMPLE: Pref Company has 2,000 shares of $50 par, $4 preferred stock, and 2,000 shares of $10 par common stock outstanding. The amount available for dividends for the year is $14,000.

Preferred Stock Common Stock$8,000

$4 dividend for each share ofpreferred stock (2000 shares)

DIVIDEND ALLOCATIONEXAMPLE: Pref Company has 2,000 shares of $50 par, $4 preferred stock, and 2,000 shares of $10 par common stock outstanding. The amount available for dividends for the year is $14,000.

Preferred Stock Common Stock$8,000

$14,000 Available for dividends- 8,000 For preferred stockholders

$ 6,000 Leftover for the common shareholders

$6,000

DIVIDEND ALLOCATIONEXAMPLE: Pref Company has 2,000 shares of $50 par, $4 preferred stock, and 2,000 shares of $10 par common stock outstanding. The company declared no dividends in year 1 and $22,000 in year 2.

Preferred Stock Common Stock

Depends on the type of Preferred Stock…Cumulative or NonCumulative

Should we go back and give the Preferred stockholders the dividend for Year 1?



Cumulative Preferred Stock accumulatesunpaid dividends from year to year.

$8,000 Year 1$8,000 Year 2



Preferred receives both years’ dividendsbefore Common Stock gets any dividends.

$8,000 Year 1$8,000 Year 2

$16,000

$6,000 $22,000-16,000



NonCumulative Preferred Stockdoes not carry dividends from year to year.

$8,000 Year 2 $14,000 $22,000-8,000

PARTICIPATING PREFERRED STOCK

Gives owners the right to share with common stock owners in dividends in excess of a stated dividend rateRare to find anymore

NonParticipating limits the preferred stock owners to the stated dividend rate

CAPITAL STOCK TRANSACTIONS

Corporations issue capital stock in exchange for cash and noncash assets.

Issuance for cash is the most common transaction

Stock may be issued:

• at par

• at a premium, or

• at a discount

Let’s look at some examples...


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Cash 50,00050,000Common Stock

Linc Corp. issues 10,000 shares of $5 par common stock at par

for $50,000 cash.

Issued common stock at par


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Cash 60,000Common Stock

What if the stock had beenissued for

for $60,000 cash?


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# of shares issued x par value10,000 shares x $5 par value

50,000


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Extra received above par value

50,000Paid-in-Capital in Excess of Par--Common Stock 10,000

Issued common stock at a

premium


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Cash 96,0004,000

Preferred Stock

Linc Corp. issues 2,000 shares of $50 par, 8% preferred stock

for $96,000 cash.

Issued preferred stock at

Discount on Preferred Stock100,000

a discount

DISCOUNTS

Seldom used because:firms generally set very low par valuespurchaser is liable to the corporation’s creditors

for the difference between the par value and the amount paid

illegal in many states

STATED VALUE STOCKEXAMPLE: Stat Company issued 5,000 shares of no-par common stock with a stated value of $10 per share for $70,000 cash.

Stock may have a stated value instead of a par value. Accounting for stated value is very similar to par value….only a few account title changes.


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# shares x stated value per share

50,000


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Cash 70,000Common Stock 50,000Paid-in-Capital in Excess of Stated Value--Com. Stock 20,000

Slight change in thetitle of the account


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Example: Noll Company issued5,000 shares of no-par common

stock for $70,000.

70,000


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Common Stock is creditedfor entire amount received.A Paid-In-Capital in Excess

account is not used.

70,000

STOCK ISSUED FOR NON-CASH ASSETS

Guideline:The assets received are recorded at the fair

market value of the assets or of the stock, whichever can be more clearly determined.

STOCK ISSUED FOR NON-CASH ASSETS

Linc Corp. issues 5,000 shares of $5 par common stock for a truck. It is hard to determine the market value of the stock but the truck has a known market value of $30,000.


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Truck 30,000Common Stock

Truck is recorded at its Fair Market Value.Common Stock is recorded at par.

Paid-in-Capital is credited for the difference.

25,000Paid-in-Capital in Excess

of Par--Common Stock 5,000

STOCK SUBSCRIPTIONS

An agreement in which a buyer (subscriber) contracts to buy shares of stock from a corporation at a specific price. Subscriber generally agrees to pay the amount

in full on a specified date or in installments.Stock is not issued until subscriber makes the

full payment.


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Stock Subscriptions Receivable 60,000Common Stock Subscribed

Example: Linc Corp received subscriptionsfor 10,000 shares of its $5 par

common stock for $60,000.




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Stock Subscriptions Receivable 60,000Common Stock Subscribed

Example: Partial Payment is received.



CashStock Subscriptions Receiv.

40,00040,000


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Example: Final Payment is received.


20,00020,000


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Stock is issued.


20,00020,000

Common Stock Subscribed 50,000Common Stock 50,000

TREASURY STOCK

When a company buys back its own stock, it’s called “Treasury Stock.”

When Treasury Stock is purchased:debited for the amount paid

• regardless of par valueTreasury Stock account is a contra-stockholders’

equity account.


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Common Treasury Stock 18,000Cash

Example: Linc Corp purchases 3,000 sharesof its $5 par common stock for $6 per share,

a total of $18,000.

18,000


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Example: Linc Corp sells 2,000 of the3,000 treasury shares for $7 per share,

a total of $14,000.

18,000

Cash 14,000Common Treasury Stock


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2,000 shares x $6 per share

18,000

Cash 14,000Common Treasury Stock 12,000


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Common Treasury Stock 18,000Cash 18,000

Cash 14,000Common Treasury Stock 12,000Paid-in-Capital from Saleof Treasury Stock 2,000

Linc sells the remaining 1,000 treasury sharesfor $5.50 per share, a total of $5,500.


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CashPaid-in-Capital from Sale

5,500

500Treasury Stock 6,000

of Treasury Stock

REVIEW OF NEW ACCOUNTSACCOUNT

NAME:TYPE OF

ACCOUNT:

Common Stock & Preferred Stock

STOCKHOLDERS’ EQUITY

PURPOSE:Credited for par or stated value (if stock has one) If no-par…credited for amount received for stock issued

BALANCE SHEET PRESENTATION:PAID-IN-CAPITAL section


NAME:TYPE OF

ACCOUNT:

Paid-In-Capital in Excess of Par (or Stated Value) -Common & Preferred Stock


PURPOSE:Credited for amount by which issue price exceeds par or stated value (not used when issuing no-par stock)

BALANCE SHEET PRESENTATION:ADDITIONAL PAID-IN-CAPITAL section


NAME:TYPE OF

ACCOUNT:

Discount on Common & Preferred Stock


PURPOSE:Debited for amount by which par or stated value exceeds issue price

BALANCE SHEET PRESENTATION:Deduction in the PAID-IN-CAPITAL section


NAME:TYPE OF

ACCOUNT:

Common & Preferred Stock Subscription Receivable

ASSET

PURPOSE:

BALANCE SHEET PRESENTATION:

RECEIVABLESARE ASSETS!!!


NAME:TYPE OF

ACCOUNT:

Common & Preferred Stock Subscription Receivable

ASSET

PURPOSE:Debited for subscription price of stock

BALANCE SHEET PRESENTATION:CURRENT ASSET section (usually)


NAME:TYPE OF

ACCOUNT:

Common & Preferred Stock Subscribed


PURPOSE:

BALANCE SHEET PRESENTATION:PAID-IN-CAPITAL section

Credited for par or stated value (if stock has one) of stock subscribed. If no-par…credited for amount of stock subscription


NAME:TYPE OF

ACCOUNT:

Paid-In-Capital from sales of Treasury Stock


PURPOSE:

BALANCE SHEET PRESENTATION:ADDITIONAL PAID-IN-CAPITAL section

Credited for excess of selling price over cost Debited for excess of cost over selling price

Stockholders’ EquityPaid-in-capital:

Equity is separated by source:Paid-in-capital = amounts contributed by owners

Retained Earnings = accumulated, undistributed earnings

Stockholders’ EquityPaid-in-capital:Preferred stock, 7%, $10 par(20,000 shares auth., 14,000 shares issued)

Preferred stock subscribed (6,000 shares)$140,000

60,000 $200,000

Preferred stock is listed firstbecause of its preferred claim

to dividends and assets.


Preferred stock subscribed (6,000 shares)

Common stock, no par(40,000 shares auth., 16,300 shares issued)

Common stock subscribed (4,000 shares)

Additional paid-in-capital:Paid-in-capital in excess of par-preferredPaid-in-capital from sale of treasury stock

Total paid-in-capital

$140,00060,000 $200,000

$163,00040,000 203,000

$56,000600 56,600

$459,600

Paid-in-capital is further separated by source….Preferred, common, subscriptions, excess of par, etc.






Total paid-in-capital

$140,00060,000 $200,000

$163,00040,000 203,000

$56,000600 56,600

$459,600

Stock characteristics are indicated….Dividend rate for preferred, Par or no par value






Total paid-in-capital Retained Earnings

Less treasury stock (2,000 shares at cost)Total stockholders’ equity

$140,00060,000 $200,000

$163,00040,000 203,000

$56,000600 56,600

$459,60060,000

$519,60022,000

$497,600

No. of shares authorized,subscribed, issued and heldas treasury are indicated.








$140,00060,000 $200,000

$163,00040,000 203,000

$56,000600 56,600

$459,60060,000

$519,60022,000

$497,600

Retained Earnings is listedafter all paid-in-capital.








$140,00060,000 $200,000

$163,00040,000 203,000

$56,000600 56,600

$459,60060,000

$519,60022,000

$497,600








$140,00060,000 $200,000

$163,00040,000 203,000

$56,000600 56,600

$459,60060,000

$519,60022,000

$497,600

Treasury stock is subtracted fromtotal of paid-in-capital and

retained earnings.

Documents

CHAPTER TWENTY-TWO CORPORATIONS: ORGANIZATIONS AND CAPITAL STOCK