CORPORATIONS STUDY OBJECTIVES After studying this chapter, you should understand: Corporate characteristics Entries for cash dividends and stock dividends

CORPORATIONSCORPORATIONS

STUDY OBJECTIVES

After studying this chapter, you should understand:

Corporate

characteristics

Entries for cash dividends

and stock dividends

How to record the

issuance of common stock

Content of retained

earnings statement

Accounting for

treasury stock

Presentation & analysis

Difference between

common & preferred stock

STUDY OBJECTIVE 1CORPORATE CHARACTERISTICS

STUDY OBJECTIVE 1CORPORATE CHARACTERISTICS

Continuous life

Management vs. ownership

Government regulation

Double taxation

Ability to acquire capital

Transferable ownership

Limited liability

Separate legal existence

Advantages

Disadvantages

Corporations may be publicly or privately owned

FORMING A CORPORATION FORMING A CORPORATION

Steps to form a corporation

Organizational costs are expensed as incurred.

A. Application

B. Charter

C. By-laws

OWNERSHIP RIGHTS OF STOCKHOLDERSOWNERSHIP RIGHTS OF STOCKHOLDERS

STOCK ISSUE CONSIDERATIONSSTOCK ISSUE CONSIDERATIONS

Authorized Maximum number of shares that may be sold indicated by charter.

Issued Shares sold to investors directly or indirectly.

Outstanding Shares currently held by investors

Par Assigned value/stated value/legal capital

No par No assigned value

STUDY OBJECTIVE 2ISSUING COMMON STOCK

STUDY OBJECTIVE 2ISSUING COMMON STOCK

Identify specific sources of paid-in capital

Maintain the distinction between paid-in capital and retained earnings.

Primary objectives in issuing common stock.

ISSUING PAR VALUE COMMON STOCK FOR CASH


(record issuance at par)

1,000 Common Stock, par $1

1,000Cash1/1/xx

CreditDebitAccountDate

If the issue price = par value, proceeds are credited to common stock.

Assume Hyrdo-Slide Inc., issues 1,000 shares of $1 par value common stock at par:

If the issue price > par value, proceeds are split between common stock and paid-in capital in excess of par value

Assume Hyrdo-Slide Inc., issues 1,000 shares of $1 par value common stock at $5 per share:



4,000 Paid-in capital in excess of par value

(record issuance in excess of par)


5,000Cash1/1/xx


REVIEW QUESTIONREVIEW QUESTION

On July 1, ABC Corporation issues 1,000 shares

of $10 par value common stock at $12 per share.

What is the entry to record this transaction?


(record issuance in excess of par)


12,000CashJuly 1


Hydro-Slide, Inc.Balance Sheet (partial)

Stockholders’ equity Paid-in-capital Common Stock $10,000

Total paid-in-capital 12,000 Retained earnings 27,000 Total stockholders’ equity $39,000

Paid-in-capital in excess of par value 2,000

The total paid-in-capital from these transactions is $12,000, and the legal capital is $10,000. If Hydro-Slide, Inc. has retained earnings

of $27,000, the stockholders’ equity section is as follows:

STOCKHOLDERS’ EQUITY SECTIONSTOCKHOLDERS’ EQUITY SECTION

ISSUING NO-PAR COMMON STOCK FOR CASH


If issue price > stated value, the

stated value is credited to common stock, and

the excess goes to paid-in excess of stated value.

If Hydro-Slide Inc. issues 5,000 shares of $5 stated value no-par stock for $8 per share:

15,000 Paid-in capital in excess of stated value

(record issuance of stated value, no par shares)

25,000 Common Stock (5000 x $5)

40,000Cash1/1/xx




(record issuance of no-par shares)

40,000 Common Stock

40,000Cash1/1/xx


If there is no stated value or par value, proceeds

are credited to common stock.

If Hydro-Slide Inc. issues 5,000 shares of no stated value stock (or no par) for $8 per share:

Attorneys helped Jordan Company incorporate, and have billed $5,000 for services. The attorneys accept 4000 shares of $1 par value common stock as payment. There is no established market price for the stock.

ISSUING COMMON STOCK FORSERVICES OR NON-CASH ASSETSISSUING COMMON STOCK FOR

SERVICES OR NON-CASH ASSETS

1,000 Paid-in capital in excess of par

(record issuance of stock to attorneys)


5,000Organization Expense1/1/xx


COST IS: FMV of consideration given up OR FMV of consideration received

whichever is more clearly determinable

1) To reissue shares to officers or employees

2) To increase trading & enhance market value

3) To have additional shares to buy other companies

4) To reduce shares outstanding, and increase EPS

5) To avoid a takeover by disgruntled investors.

STUDY OBJECTIVE 3ACCOUNTING FOR TREASURY STOCK

STUDY OBJECTIVE 3ACCOUNTING FOR TREASURY STOCK

Treasury stock is a corporation's own stock

that has been reacquired but not retired.

Why do companies purchase treasury stock?

Before the purchase of the treasury stock, the stockholders’ equity is as follows:

Mead, Inc. Balance Sheet (partial)

Stockholders’ equity Paid -in capital

Common stock, $5 par, 100,000 shares Issued and outstanding Retained earnings

Total stockholders’ equity

$ 500,000

200,000

$ 700,000

STOCKHOLDERS EQUITY SECTIONWITH NO TREASURY STOCK

STOCKHOLDERS EQUITY SECTIONWITH NO TREASURY STOCK

If Mead, Inc. has 100,000 shares of $5 par value common stock outstanding (all issued at par value) and it decides to acquire

4,000 shares of its stock at $8 per share, the entry is:

PURCHASE OF TREASURY STOCKPURCHASE OF TREASURY STOCK

(record purchase of treasury stock)

32,000 Cash

32,000Treasury stockFeb 1


Cost method

Mead, Inc.Balance Sheet (partial)

Stockholders’ equityPaid-in capital

Common stock, $5 par, 100,000 shares issued and 96,000 shares outstandingRetained earnings

Total paid-in capital and retained earningsLess: Treasury stock (4,000 shares) Total stockholders’ equity

$500,000 200,000 700,000 32,000 $668,000

STOCKHOLDERS EQUITY SECTIONWITH TREASURY STOCK

STOCKHOLDERS EQUITY SECTIONWITH TREASURY STOCK

The acquisition of treasury stock REDUCES stockholders’ equity

The stockholders’ equity section of Mead, Inc. after purchase of treasury stock is as follows:

If 1,000 shares of treasury stock of Mead, Inc., previously acquired at $8 per share, are sold at $10 per

share on July 1. The entry is:

DISPOSAL OF TREASURY STOCK ABOVE COST

DISPOSAL OF TREASURY STOCK ABOVE COST

2,000 Paid-in capital from treasury stock

(record sale of treasury stock above cost)

8,000 Treasury Stock

10,000CashJuly 1


The $2,000 credit is NOT A GAIN on Sale of Treasury Stock

If Mead, Inc. sells an additional 800 shares of treasurystock on October 1 at $7 per share, the entry is:

DISPOSAL OF TREASURY STOCK BELOW COST

DISPOSAL OF TREASURY STOCK BELOW COST

6,400 Treasury stock

(record sale of treasury stock below cost)

800Paid-in capital from treasury stock

5,600CashOct 1


The sale of treasury stock increases

TOTAL ASSETS and STOCKHOLDERS’ EQUITY

If Mead, Inc., sells its remaining 2200 shares at $7 per Share on December 1, the entry is:

DEPLETING THE BALANCE IN PAID-IN CAPITAL FROM TREASURY STOCK

DEPLETING THE BALANCE IN PAID-IN CAPITAL FROM TREASURY STOCK

1,000Retained earnings

17,600 Treasury stock

(record sale of 2200 shares of treasury stock)

1,200Paid-in capital from treasury stock

15,400CashDec 1


When the credit balance in paid-in capital from treasury stock is

depleted, the difference is debited to RETAINED EARNINGS.

Preferred stock has priority over common stock in terms of

No voting rights.

Identified separately from other stock and paid in capitals.

STUDY OBJECTIVE 4

PREFERRED STOCKSTUDY OBJECTIVE 4

PREFERRED STOCK

Distribution of earnings

Assets in liquidation

CUMULATIVE DIVIDENDPreferred stockholders must be paid both

current and prior year dividends before common stockholders receive any dividends.

DIVIDENDS IN ARREARSPreferred dividends not declared in a given period.

Not considered a liability, but disclosed in the notes to the financial statements.

DIVIDEND PRFERENCESDIVIDEND PRFERENCES

Dividends in arrears ($35,000 x 2) $ 70,000

Current year dividends 35,000

Total preferred dividends $105,000

CUMULATIVE DIVIDENDCUMULATIVE DIVIDEND

If Scientific-Leasing has 5,000 shares of 7%, $100 par value cumulative preferred stock outstanding, the annual dividend is $35,000 (5,000 shares x $7 per share). If dividends are two years in arrears, preferred stockholders should receive the

following before any dividends are paid to common stockholders.

STUDY OBJECTIVE 5

CASH AND STOCK DIVIDENDSSTUDY OBJECTIVE 5

CASH AND STOCK DIVIDENDS

(declaration of a cash dividend)

50,000 Dividends payable

50,000Dividends DeclaredDec 1


On December 1, 2006, Media General declares a 50 cents per share dividend on 100,000 shares of $10 par value stock:

Declaration Date

STUDY OBJECTIVE 5



Dec 30


RECORD DATE

STUDY OBJECTIVE 5



(payment of cash dividend)

50,000 Cash

50,000Dividends payableJan 23


On January 23, 2007, Media General pays the previously declared dividend.

PAYMENT DATE

ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON


Assume that IBR Inc. has 1,000 shares of 8%, $100 par cumulative preferred stock and 50,000 shares of $10 par

common stock outstanding at December 31, 2006.

If the Board of Directors declares a $6,000 cash dividend on December 31, the entire amount will go

preferred stockholders because their annual dividend is $8,000,(1,000 shares x $8) .

(payment of cash dividend)

6,000 Dividends payable

6,000Dividends Declared Dec 31


Preferred dividends are now $2000 in arrears

Total dividend $50,000

Allocated to preferred stock

Remainder allocated to common stock $40,000

• Dividend in arrears, 2002 (1,000 x $2) $2,000

• 2006 dividend (1,000 x $8) 8,000 10,000

At December 31, 2007, IBR declares a $50,000 cash dividend. The allocation of the dividend is shown above.



STOCK DIVIDENDSSTOCK DIVIDENDS

A pro rata distribution of stock to existing stockholders.

Decreases retained earnings and increases in paid-in capital.

Small dividend (< 20%) valued at FMV

Large dividend (>20%) valued at Par/Stated

No effect on Total Assets or Stockholders’ Equity.

ENTRIES FOR STOCK DIVIDENDSENTRIES FOR STOCK DIVIDENDS

Medland Corporation has a balance of $300,000 in retainedearnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The FMV of its

stock is $15 per share and the 5000 shares are issued.The following entries would be made at the date of declaration:

(declaration of 10% stock dividend )

25,000 Paid-in capital in excess of par

50,000 Common stock dividends distributable

75,000Retained earningsDeclaration


STATEMENT PRESENTATIONOF DIVIDENDS DISTRIBUTABLE

STATEMENT PRESENTATIONOF DIVIDENDS DISTRIBUTABLE

Paid-in capital

Common stock 500,000

Common stock dividends distributable 50,000 550,000

Common Stock Dividends Distributable is a stockholders’ equity account. If a balance sheet is prepared before the dividend shares are issued,

the distributable account is reported in paid-in capital.

50,000 Common stock

50,000Common stock dividends distributableDistribution

(distribution of 10% stock dividend )


The following entry is made when the stock dividend is distributed.

STOCK DIVIDEND EFFECTSSTOCK DIVIDEND EFFECTS

55,00050,000Outstanding shares

$800,000$800,000 Total stockholders’ equity

225,000300,000 Retained earnings

575,000500,000 Total paid-in capital


$550,000$500,000 Common stock, $10 par

Paid-in capital

Stockholders’ equity

After

Dividend

Before

Dividend

Stock dividends change the composition of stockholders’ equity because

a portion of retained earnings is transferred to paid-in capital.

A multiple of existing shares issued to existing stockholders.

Total number of shares increases, par value decreases.

No effect on total stockholders’ equity.

No journal entry required.

STOCK SPLITSSTOCK SPLITS

100,00050,000Outstanding shares

$800,000$800,000 Total stockholders’ equity

300,000300,000 Retained earnings

500,000500,000 Total paid-in capital

00 Paid-in capital in excess of par value

$500,000$500,000 Common stock,

Paid-in capital


After

Split

Before

Split

STOCK SPLIT EFFECTSSTOCK SPLIT EFFECTS

2 for 1 stock split.

REVIEW QUESTIONREVIEW QUESTION

Mickey Mouse Corporation has 450,000 shares of $3 par value common stock outstanding.

If the company announces a 3 for 1 stock split, what affect will this have on shares outstanding and par value?

$1.00 par value$3.00 par value

1,350,000 shares450,000 shares

After splitBefore split

What is the journal entry to reflect the stock split?

No journal entry required.

STUDY OBJECTIVE 6RETAINED EARNINGS

STUDY OBJECTIVE 6RETAINED EARNINGS

Net income that is retained in the business.

Net losses reduce retained Earnings.

Net losses are not debited to paid-in capital accounts.

RETAINED EARNINGS

Net loss

Prior period adjustments

Dividends

Some treasury stock disposals

Net income

Prior period adjustments

$750,000 Total stockholders’ equity

(50,000) Retained earnings (deficit)

$800,000 Common stock

Paid-in capital


STOCKHOLDERS’ EQUITY WITH DEFICIT

STOCKHOLDERS’ EQUITY WITH DEFICIT

Balance Sheet (partial)

A debit balance in retained earnings is a DEFICIT.

Restrictions make a portion of the balance unavailable for dividends.

RETAINED EARNINGS RESTRICTIONS

RETAINED EARNINGS RESTRICTIONS

CAUSES

LegalRestrictions

(treasury stock)

ContractualRestrictions

(loan covenants)

VoluntaryRestrictions

(plant expansion)

PRIOR PERIOD ADJUSTMENTSPRIOR PERIOD ADJUSTMENTS

Correction of a material error in reporting

net income in previously issued financial statements. :

300,000 Accumulated depreciation

300,000Retained earnings2006

(adjust for PY understatement)


General Microwave understated 2005 depreciation expense by $300,000. They discover the error in 2006,

and make the following corrective entry.

General MicrowaveRetained Earnings Statement (partial)

Balance, January 1. as reported $800,000

Correction for prior period overstatement of net income (depreciation error)

(300,000)

Balance, January 1, as adjusted $500,000

PRIOR PERIOD ADJUSTMENTSPRIOR PERIOD ADJUSTMENTS

A prior period adjustment is reported as an adjustment

to the opening balance of retained earnings:

STUDY OBJECTIVE 7PRESENTATION & ANALYSIS

STUDY OBJECTIVE 7PRESENTATION & ANALYSIS

RETURN ON EQUITYRETURN ON EQUITY

Net income less

preferred dividends

Average Common

Stockholders Equity

Return on Common

Stockholders’ Equity=

Measures how many dollars of net income were earned

For every dollar invested by common stockholders

Documents

CORPORATIONS STUDY OBJECTIVES After studying this chapter, you should understand: Corporate characteristics Entries for cash dividends and stock dividends