BY R A C H E L L E A G AT H A , C PA , M B A

Corporations & Stock Transactions

Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

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1. Describe the nature of the corporate form of organization.2. Describe the two main sources of stockholders’ equity.

3. Describe and illustrate the characteristics of stock, classes of stock, and entries for issuing stock.

Objectives:

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4. Journalize the entries for cash dividends and stock dividends.5. Journalize the entries for treasury stock transactions.

6. Describe and illustrate the reporting of stockholders’ equity.

7. Describe the effect of stock splits on corporate financial statements.

Objectives:

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Describe the nature of the

corporate form of organization.

Objective 1

Objective 1

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Characteristics of a Corporation

A corporation is a legal entity, distinct and separate

from the individuals who create and operate it. As a legal entity, a corporation

may acquire, own, and dispose of property in its

own name.

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The stockholders or shareholders who own

the stock own the corporation. Corporations whose shares of stock are traded in public markets

are called public corporations.

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Corporations whose shares are not traded publicly are usually owned by a small

group of investors and are called nonpublic or private

corporations. The stockholders of all

corporation have limited liability.

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The stockholders control a corporation by electing a board of directors. The

board meets periodically to establish corporate policy.

It also selects the chief executive officer (CEO)

and other major officers.

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EmployeesEmployees

StockholdersStockholders

OfficersOfficers

Board of DirectorsBoard of Directors

Exhibit 1 Organizational Structure of a Corporation

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Advantages of the Corporate Form

A corporation exists separately from its owners.

A corporation’s life is separate from its owners; therefore, it exists indefinitely.

The corporate form is suited for raising large amounts of money from stockholders.

(Continued)

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Advantages of the Corporate Form

A corporation sells shares of ownership, called stock. Stockholders can transfer their shares of stock to other stockholders.

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

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Disadvantages of the Corporate Form

Stockholders control management through a board of directors.

As a separate legal entity, the corporation is subject to taxation. Thus, net income distributed as dividends will be taxed at both the corporate and individual levels.

Corporations must satisfy many regulatory requirements.

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1. First step in forming a corporation is to file an application of incorporation with the state.

Forming a Corporation

Because state laws differ, corporations often organize in states with more favorable laws.

More than half of the largest companies are incorporated in Delaware (see Exhibit 3 in Slide 14). (Continued)

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Corporations and Their States of Incorporation

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2. After the application is approved, the state grants a charter or articles of incorporation which formally create the corporation.3. Management and the board of directors prepare bylaws which are operation rules and procedures.

Forming a Corporation

(Concluded)

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Organization Structure of a Corporation

Costs may be incurred in organizing a corporation. The recording of a corporation’s organizing costs of $8,500 on January 5 is shown below:

Jan. 5Organizational Expense 8 500 00Cash 8 500 00

Paid costs of organizing the corporation.

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Describe the two main sources of

stockholders’ equity.

Objective 2

Objective 2

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The owner’s equity in a corporation is called stockholders’ equity, shareholders’ equity, shareholders’ investment, or capital.

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The two sources of capital found in the Stockholders’ Equity section of a balance sheet are paid-in capital or contributed capital (capital contributed to the corporation by stockholders and others) and retained earnings (net income retained in the business).

Stockholders’ Equity

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Stockholders’ Equity Section of a Corporate Balance Sheet

Stockholders’ EquityPaid-in capital: Common stock $330,000Retained earnings 80,000 Total stockholders’ equity $410,000

If there is only one class of stock, the account is entitled Common Stock or Capital Stock.

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A debit balance in Retained Earnings is called a deficit. Such a balance results from

accumulated net losses.

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Describe and illustrate the

characteristics of stock, classes of

stock, and entries for issuing stock.

Objective 3

Objective 3

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Characteristics of Stock

The number of shares of stock that a corporation is

authorized to issue is stated in the charter. A corporation may reacquire some of the stock that has been issued. The stock remaining in the

hands of stockholders is then called outstanding stock.

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Shares of stock are often assigned a monetary amount, called par. Corporations may

issue stock certificates to stockholders to document their ownership. Some corporations

have stopped issuing stock certificates except on special

request.

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Stock issued without a par is called no-par stock. Some states require the board of directors to assign a stated

value to no-par stock.

Some state laws require that corporations maintain a minimum stockholder

contribution, called legal capital, to protect creditors.

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Authorized

Number of Shares Authorized, Issued, and Outstanding

IssuedOutstanding

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1. The right to vote in matters concerning the corporation.

2. The right to share in distributions of earnings.

3. The right to share in assets on liquidation.

Major Rights That Accompany Ownership of a Share of Stock

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The two primary classes of paid-in capital are common stock and preferred stock. The primary attractiveness of preferred stocks is that they

are preferred over common as to dividends.

Two Primary Classes of Paid-In Capital

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A corporation has 1,000 shares of $4 preferred stock and 4,000 shares of common stock outstanding. The net income, amount of earnings retained, and the amount of earnings distributed are as follows:

Net income $20,000 $9,000 $62,000Amount retained 10,000 6,000 40,000Amount distributed $10,000 $3,000 $22,000

2006 2007 2008

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Dividends to Common and Preferred Stock

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Sandpiper Company has stock 20,000 shares of 1% preferred stock of $100 par and 100,000 shares of $50 par common stock. The following amounts were distributed as dividends:

Year 1: $10,000Year 2: 25,000Year 3: 80,000

Determine the dividends per share for preferred and common stock for each year.

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Dividends per share:Preferred $0.50 $1.00 $1.00Common stock None $0.05 $0.60

Year 1 Year 2 Year 3

Amount distributed $10,000 $25,000 $80,000Preferred dividend (20,000shares) 10,000 20,000 20,000Common dividend (100,000

shares) $ 0 $ 5,000 $60,000

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A corporation is authorized to issue 10,000 shares of preferred stock, $100 par, and 100,000 shares of common stock, $20 par. One-half of each class of authorized shares is issued at par for cash.

Issuing Stock

Cash 1,500 000 00

Issued preferred stock

and common stock at

par for cash.

Preferred Stock 500 000 00Common Stock 1,000 000 00

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When a stock is issued for a price that is

more than its par, the stock has sold at a premium. When

stock is issued for a price that is less than its par, the stock has sold at a discount.

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Caldwell Company issues 2,000 shares of $50 par preferred stock for cash at $55.

Cash 110 000 00

Issued $50 par preferred stock at $55.

Preferred Stock100 000 00

Paid-in Capital in Excess of

Par—Preferred Stock10 000 00

Premium on Stock

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A corporation acquired land for which the fair market value cannot be determined. The corporation issued 10,000 shares of $10 par common that has a current market value of $12 in exchange for the land.

Land 120 000 00

Issued $10 par common stock valued at $12 per share, for land.

Common Stock100 000 00

Paid-in Capital in Excess of Par20 000 00

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A corporation issues 10,000 shares of no-par common stock at $40 a share. Cash 400 000 00

Issued 10,000 shares of no-par common stock at $40.

Common Stock400 000 00

No-Par Stock

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At a later date, the corporation issues 1,000 additional shares at $36.

Cash 36 000 00

Issued 1,000 shares of

no-par common stock at

$36.

Common Stock36 000 00

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Stated Value

Some states require that the entire

proceeds from the issue of no-par stock be

recorded as legal capital. In other

states, no-par stock may be assigned a stated value per

share.

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Using the same data as we used for par the transaction is recorded as follows:

Cash 400 000 00

Issued 10,000 shares

of no-par common at

$40. Stated value,

$25.

Common Stock250 000 00

Stated Value

Paid-in Capital in Excess of

Stated Value 150 000 00

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Cash 36 000 00

Issued 1,000 shares

of no-par common at

$36. Stated value,

$25.

Common Stock25 000 00 Paid-in Capital in Excess of

Stated Value 11 000 00

The corporation issued 1,000 shares of no-par common stock at $36 (stated value, $25).

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On March 6, Limerick Corporation issued for cash 15,000 shares of no-par common stock at $30. On April 13, Limerick issued at par 1,000 shares of 4%, $40 par preferred stock for cash. On May 19, Limerick issued for cash 15,000 shares of 4%, $40 par preferred stock at $42.

Journalize the entries to record the March 6, April 13, and May 19 transactions.

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Mar. 6 Cash 450,000Common Stock 450,000

(15,000 shares x $30)

Apr.13 Cash 40,000Preferred Stock 40,000

(1,000 shares x $40)

May19 Cash 630,000Preferred Stock 600,000Paid-in Capital in Excess of Par 30,000

(15,000 shares x $42)

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Journalize the entries for cash dividends and

stock dividends.

Objective 4Objective 4

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Cash Dividends

A cash distribution of earnings by a corporation to its stockholders is called a cash dividend. There are usually three conditions that a corporation must meet to pay a cash dividend.1. Sufficient retained earnings

2. Sufficient cash

3. Formal action by the board of directors

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First is the date of declaration. Assume that on December 1, Hiber Corporation declares a $42,500

dividend ($12,500 to the 5,000 preferred stockholders and

$30,000 to the 100,000 common stockholders.

Three Important Dividend Dates

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Dec.1 Cash Dividends 42 500 00

Declared cash dividend.

Cash Dividends Payable42 500 00

Heber Corporation records the $42,500 liability on the declaration date.

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The second important date is the date of record. For Hiber

Corporation this would be December 10. No

entry is required since this date merely

determines which stockholders will receive

the dividend.

Three Important Dividend Dates

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The third important date is the date of payment. On January 2, Hiber issues dividend checks.

Three Important Dividend Dates

Jan. 2 Cash Dividends Payable 42 500 00

Paid cash dividend.

Cash 42 500 00

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The important dates in connection with a cash dividend of $75,000 on a corporation’s

common stock are February 26, March 30, and April 2. Journalize the entries required on

each date.

Feb. 26Cash Dividends 75,000Cash Dividends Payable 75,000

Mar.30 No entry required.

Apr. 2 Cash Dividends Payable 75,000Cash 75,000

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A distribution of dividends to

stockholders in the form of the firm’s

own shares is called a stock dividend.

Stock Dividends

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On December 15, the board of directors of Hendrix

Corporation declares a 5% stock dividend of 100,000 shares (2,000,000 shares x 5%) to be issued on January 10 to stockholders of record

on December 31. The market price on the declaration date

is $31 a share.

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Dec. 15 Stock Dividend (100,000 x $31 market)3,100 000 00

Declared 5% (100,000

share) stock dividend

on $20 par common

stock with a market

value of $31 per share.

Stock Dividend Distributable

2,000 000 00 Paid-in Capital in Excess of

Par—Common Stock 1,100 000 00

The entry to record the declaration of the 5 percent stock dividend is as follows:

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Jan.10 Stock Dividends Distributable 2,000 000 00

Issued stock for the stock

dividend.

Common Stock2,000 000 00

On January 10, the number of shares out-standing is increased by 100,000. The following entry records the issue of the stock:

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Vienna Highlights Corporation has 150,000 shares of $100 par common stock outstanding. On June 14, Vienna Highlights declared a 4%

stock dividend to be issued August 15 to stockholders of record on July 1. The market

price of the stock was $110 a share on June 14.

Journalize the entries required on June 14, July 1, and August 15.

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June 14 Stock Dividends (150,000 x 4% x $110) 660,000Stock Dividends Distributable (6,000 x $100) 600,000Paid-in Capital in Excess of Par— Common Stock ($660,000 – $600,000)

60,000

July 1 No entry required.

Aug.15 Stock Dividend Distributable 600,000Common Stock 600,000

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Journalize the entries for

treasury stock transactions.

Objective 5

Objective 5

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Occasionally, a corporation buys back its own stock to provide shares for resale to

employees, for reissuing as a bonus to employees, or for

supporting the market price of the stock. This stock is referred to as treasury

stock.

Treasury Stock Transactions

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On January 5, a firm purchased 1,000 shares of treasury stock (common stock, $25 par) at $45 per share. The cost method for accounting for treasury stock is used.

Treasury Stock 45 000 00

Purchased 1,000 shares of

treasury stock at $45.

Cash45 000 00

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Later, 200 shares of treasury stock were sold for $60 per share.

Cash 12 000 00

Sold 200 of treasury

stock at $60.

Treasury Stock*9 000 00

Paid-in Capital from Sale of

Treasury Stock

3 000 00

*The amount debited to Treasury Stock per share when purchased is the amount per share that must be credited to that account when sold.

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Sold 200 shares of treasury stock at $40 per share.

Cash 8 000 00

Sold 200 of treasury

stock at $40.

Treasury Stock9 000 00

Paid-in Capital from Sale

of

Treasury Stock

1 000 00

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On May 3, Buzz Off Corporation reacquired 3,200 shares of its common stock at $42 per share. On July 22, Buzz Off sold 2,000 of the reacquired shares at $47 per share. On August 30, Buzz Off sold the remaining shares at $40 per share.

Journalize the transactions of May 3, July 22, and August 30.

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May 3 Treasury Stock (3,200 x $42) 134,400Cash 134,400

July22 Cash (2,000 x $47) 94,000Treasury Stock (2,000 x $42) 84,000Paid-in Capital from Sale of Treasury Stock [2,000 x ($47 – $42)] 10,000

Aug.30 Cash (1,200 x $40) 48,000Paid-in Capital from Sale of Treasury Stock [1,200 x ($42 – $40)] 2,400

Treasury Stock (1,200 x $42) 50,400

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Describe and illustrate the reporting of

stockholders’ equity.

Objective 6

Objective 6

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Stockholders’ Equity Section of a Balance Sheet

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Using the following accounts and balances, prepare the Stockholders’ Equity section of the balance sheet. Forty

thousand shares of common stock are authorized and 5,000 shares have been reacquired.

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Common Stock, $50 par $1,500,000Paid-in Capital in Excess of Par 160,000Paid-in Capital from Sale of Treasury Stock 44,000Retained Earnings 4,395,000Treasury Stock 120,000

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Stockholders’ Equity

Paid-in capital:Common stock, $50 par

(40,000 shares authorized,30,000 shares issued) $1,500,000

Excess of issue price over par 160,000 $1,660,000From sale of treasury stock 44,000 Total paid-in capital $1,704,000

Retained earnings 4,395,000Total $6,099,000

Deduct treasury stock (5,000 shares at cost) 120,000Total stockholders’ equity $5,979,000

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Retained Earnings Statement

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Restrictions

The retained earnings available for use as dividends may be limited by the actions

of a corporation’s board of directors. These amounts,

called restrictions or appropriations, remain part

of the retained earnings. However, they must be

disclosed, usually in the notes to the financial statements.

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Statement of Stockholders’ Equity

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Dry Creek Camera Inc. reported the following results for the year ending March 31, 2008:

Retained earnings, April 1, 2007 $3,338,500Net income 461,500Cash dividends declared 80,000Stock dividends declared 120,000

Prepare a retained earnings statement for the fiscal year ended March 31, 2008.

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DRY CREEK CAMERAS INC.RETAINED EARNINGS STATEMENTFor the Year Ended March 31, 2008

Retained earnings, April 1, 2007 $3,338,500Net income $461,500Less dividends declared 200,000Increase in retained earnings 261,500Retained earnings, March 31, 2008 $3,600,000

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Describe the effect of stock

splits on corporate financial

statements.

Objective 7

Objective 7

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A corporation sometimes reduces the par or stated value of

their common stock and issues a proportionate number of additional

shares. This process is called a stock split.

Stock Splits 13-7

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Rojek Corporation has 10,000 shares of $100

par common stock outstanding with a

current market price of $150 per share.

The board of directors declares a 5-for-1

stock split.

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BEFORE STOCK SPLIT

4 shares, $100 par

$400 total par value

20 shares, $20 par

AFTER 5:1 STOCK SPLIT

$400 total par value

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Since a stock split changes only the par or stated value and the number of shares

outstanding, it is not recorded by a journal entry. The details of the stock split are normally disclosed in the

notes to the financial statements.

Summary Nature of Corporations

Main sources of stockholders

equity

Characteristics of stock

Journalize transactions

Reporting of Stockholders

Equity