Stockholder Equity

8/3/2019 Stockholder Equity

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PROJECT

ON

ACCOUNTING

SUBMITTED TO:

SIR KASHIF LUQMAN

SUBMITTED BY:

HAMMAD BIN AZAM HASHMI (046)

USAMA JAVED (003)

SHAMAAIM ZAMAN (131)

WALEED AHMAD (149)

AHSAN ALAM ()


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STOCKHOLDER EQUITY

CORPORATIONS:

A corporation is a formal business association with a publicly registered

charter recognizing it as a separate legal entity having its own privileges,

and liabilities distinct from those of its members. There are many different

forms of corporations, most of which are used to conduct business.

Corporations exist as a product of corporate law, and their rules balance

the interests of the management who operate the corporation, creditors,

shareholders, and employees who contribute their labor.

CHARACTERSTICS:

A number of characteristics distinguish a corporation from a sole

proprietor or partnership.

Unlimited life

As a corporation is owned by stockholders and managed by employees, the

sale of stock, death of a stockholder, or inability of an employee tofunction does not impact the continuous life of the corporation. Its charter

may limit the corporation's life although the corporation may continue if

the charter is extended.

Limited liability

The liability of stockholders is limited to the amount each has invested in

the corporation. Personal assets of stockholders are not available tocreditors or lenders seeking payment of amounts owed by the corporation.

Creditors are limited to corporate assets for satisfaction of their claims.


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Separate legal entity

The corporation is considered a separate legal entity, conducting business

in its own name. Therefore, corporations may own property, enter into

binding contracts, borrow money, sue and be sued, and pay taxes.Stockholders are agents for the corporation only if they are also employees

or designated as agents.

Relative ease of transferring ownership rights

A person who buys stock in a corporation is called a stockholder and

receives a stock certificate indicating the number of shares of the company

she/he has purchased. Particularly in a public company, the stock can beeasily transferred in part or total at the discretion of the stockholder. The

stockholder wishing to transfer (sell) stock does not require the approval of

the other stockholders to sell the stock. Similarly, a person or an entity

wishing to purchase stock in a corporation does not require the approval of

the corporation or its existing stockholders before purchasing the stock.

Once a public corporation sells its initial offering of stock, it is not part of

any subsequent transfers except as a record keeper of share ownership.

Privately held companies may have some restrictions on the transfer ofstock.

Professional management

Investors in a corporation need not actively manage the business, as most

corporations hire professional managers to operate the business. The

investors vote on the Board of Directors who are responsible for hiring

management.

Ease of capital acquisition

A corporation can obtain capital by selling stock or bonds. This gives a

corporation a larger pool of resources because it is not limited to the

resources of a small number of individuals. The limited liability and ease of


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transferring ownership rights makes it easier for a corporation to acquire

capital by selling stock, and the size of the corporation allows it to issue

bonds based on its name.

Government regulations

The sale of stock results in government regulation to protect stockholders,

the owners of the corporation. State laws usually include the requirements

for issuing stock and distributions to stockholders. The federal securities

laws also govern the sale of stock. Publicly held companies with stock

traded on exchanges are required to file their financial statements and

additional informative disclosures with the Securities and Exchange

Commission. Certain industries, such as banks, financial institutions, andgaming, are also subject to regulations from other governmental agencies.

PROBLEM OF CORPORATIONS:

Disadvantages

Fees: It costs money to incorporate. There are four types of fees: a fee tofile the Articles of Incorporation with the Secretary of State, a first-year

franchise tax prepayment, fees for various governmental filings, and

attorneys' fees. But every year, tens of thousands of businesses choose to

incorporate online without the use of an attorney. For example, basic

incorporation before filing fees at a site like LegalZoom.com costs just $99.

Formalities: The proper corporate formalities of organizing and running a

corporation must be followed, to receive the benefits of being acorporation.

Paperwork: Paperwork is a huge component of the corporate formalities

that must follow. Reports and tax returns must be compiled and filed in a

timely fashion; business bank accounts and records must be maintained


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and kept separate from personal accounts and assets; records must be kept

of corporate actions, including meetings of shareholders and Board of

Directors; and licenses must be maintained.

Disclosure of names of corporate officers and directors: Most states do notrequire that names of shareholders be a matter of public record; however,

many states require that the names and addresses of corporate officers and

directors be listed on one or more documents filed with the Secretary of

State.

Dissolution: Since corporations have a perpetual existence, states provide

a mechanism for dissolving a corporation and liquidating its assets.

Dissolution does not happen automatically. A corporation can be dissolvedvoluntarily or involuntarily. A corporation's officers and directors are

charged with responsibility for dissolving the corporation, including

gathering corporate assets, paying creditors and outstanding claims, and

distributing the remaining assets to shareholders.

Tax consequences: C corporations have potential double-tax

consequencesonce when the company makes its profit, and a second

time when dividends are paid to shareholders. S corporations can mitigatethis tax issue.


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TYPES OF CORPORATIONS:

Businesses may choose from a variety of corporate entities, based on their

needs. Below are useful descriptions.

General Corporation

A general corporation, also known as a C corporation, is the most

common corporate structure. A general corporation may have an unlimited

number of stockholders. Consequently, it is usually chosen by those

companies planning to have more than 30 stockholders or large public

stock offerings. Since a corporation is a separate legal entity, astockholders personal liability is usually limited to the amount of

investment in the corporation and no more.

Close Corporation

A close corporation is most appropriate for the individual starting a

company alone or with a small number of people. There are a few

significant differences between a general corporation and a closecorporation. A close corporation limits stockholders to a maximum of 30.

In addition, many close corporation statutes require that the directors of a

close corporation must first offer the shares to existing stockholders before

selling to new stockholders. Not all states recognize close corporations.

Subchapter S Corporation

A Subchapter S Corporation is a general corporation that has elected a

special tax status with the IRS after the corporation has been formed.

Subchapter S corporations are most appropriate for small business owners

and entrepreneurs who prefer to be taxed as if they were still sole

proprietors or partners. When a general corporation makes a profit, it pays

a federal corporate income tax on the profit. If the company also declares a


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dividend, the stockholders must report the dividend as personal income

and pay more taxes.

S Corporations avoid this double taxation (once at the corporate level

and again at the personal level) because all income or loss is reported onlyonce on the personal tax returns of the stockholders.

For many small businesses, the S Corporation offers the best of both

worlds, combining the tax advantages of a sole proprietorship or

partnership with the limited liability and enduring life of a corporate

structure.

S Corporation Restrictions

To elect S Corporation status, your corporation must meet specificguidelines.

All stockholders must be citizens or permanent residents of theUnited States.

The maximum number of stockholders for an S Corporation is 75. If an S Corporation is held by an electing small business trust, then

all beneficiaries of the trust must be individuals, estates or charitableorganizations. Interests in the trust cannot be purchased.

S Corporations may only issue one class of stock. No more than 25 percent of the gross corporate income may be

derived from passive income.


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Corporate Structure:

While there might be slight variations in the way a corporation is set up,the corporate structure does follow a basic pattern. How a corporation is

ownedpublic or privatewill also dictate the corporate structure. Tosomeone unfamiliar with the inner workings of the corporate world, it canbe seem very confusing.

A Two-Tiered System

Stockholders are the owners of publicly owned corporations. Allowingeach stockholder a vote or say on every matter would be unwieldy, socorporations set up a Board of Directors. The members of the Board of

Directors are elected and voted on by the stockholders. Members of theBoard of Directors come from within the corporations managementstructure (oftentimes the CEO or other top executives will be members ofthe Board), and they come from high-powered business, political, andacademic leaders who are not otherwise affiliated with the corporation. TheBoard of Directors is run by a chairman who is elected to the position bythe other members of the Board. The chairman is, technically, the topperson within the corporations management structure.

The other tier in the system is the management system within thecorporation. These are the people who run the company on a daily basis.The top three positions in a typical corporation are the Chief ExecutiveOfficer (CEO), the Chief Operating Officer (COO), and the ChiefFinancial Officer (CFO). The CEO is responsible for the overall businessoperation and directly reports to the chairman of the Board of Directors.The COO is the hands-on management position, looking after sales andproduction activity and personnel. The CFO is responsible for tracking the

financial well-being in the company, as well as providing regular reports tothe Board of Directors, to the stockholders, and to the Securities andExchange Commission. These three positions also carry other titles. TheCEO can also be the president of the company; this title is designateddepending on his position within the Board of Directors. The COO andCFO are usually senior vice presidents.


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Corporate Ladder

Everyone in the company ultimately reports to the Chairman of the Boardof Directors. Within the management structure, the COO and CFO report

to the CEO directly. From that point, the corporate structure widens to thevice presidents who oversee particular production or location areas, tomanagers who oversee a smaller region, and finally to the employees whomake up the bulk of the corporations workforce.

RIGHTS OF STOCKHOLDERS

A. Common Stock (basic rights):

Voting rightsDividends - right to receive share of corp. earnings as their return on

investment (ROI)

Preemptive Right - right to maintain a proportionate ownershipinterest when new shares are issued.

Liquidation - Right to a proportionate share of assets uponliquidation

Preferred Stock (basic rights):

Dividend Preference - right to receive a dividend beforecommon stockholders

Liquidation PreferenceNo voting rights


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PREFERRED SHARES

FEATURES OF PREFERRED SHARES:

The following features are usually associated with preferred stock:

Preference in dividends. Preference in assets in the event ofliquidation. Convertible into common stock. Callable at the option of the corporation. Nonvoting.

TYPES OF PREFERRED SHARES:

Cumulative

event financial conditions prevent a company from paying the fixeddividend, the unpaid amount accrues and must be paid at a later date (andbefore any common stock dividends are paid). Some cumulative stock isclassified as "prior" or "preference." Companies often have several issuesof preferred stock. In the event a dividend is delayed, those with prior or

preference status get paid first.

Callable

ght to redeem or "call" preferredshares of stock as long as they pay for the shares at or above the marketprice. Many investors are wary of callable preferred stocks and with goodreason. If economic conditions lead to a significant lowering of interestrates, calling preferred stock saves the company money, but the

shareholders lose out on the income provided by the shares.

Convertible

means the stock can be exchanged after a stated time for a predeterminednumber of common stock shares. The shareholder has this option but is
http://en.wikipedia.org/wiki/Liquidationhttp://en.wikipedia.org/wiki/Liquidation


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under no obligation to convert the shares. If the owner does exchange thepreferred shares for common stock, it's a one-way street. The stock cannotbe switched back to preferred shares.

STOCKHODER EQUITY ACCOUNTING

Two Sources of Equity Capital

1. Contributed Capital- investments by stockholders2. Earned Capital- earnings retained in the business (Retained

Earnings)

Retained Earnings

a. Increased by Net Income (with acredit)

b. Decreased by net losses & dividends (a debit)

Beginning Retained Earnings $ XX

+ Net Income (- Net Loss) XX

- Dividends (XX)

Ending Retained Earnings $ XX


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Sample Stockholders Equity section of Balance Sheet:

Preferred Stock (# shares issued x $ par) $ XX

Common Stock (# shares issued x $ par) XX

Additional Paid in Capital: Preferred XX

Common XX

Treasury XX

Total Contributed Capital XX

Retained Earnings XX

Treasury Stock (shares x $ cost) (XX)

Total Stockholders Equity XX


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CAPITAL STOCK

1. Authorized Shares: total no. of shares that may be issued

2. Issued Shares: total no. of shares issued to stockholders since

formation

3. Outstanding Shares: no. of shares held by outside stockholders

4. Treasury Stock

ISSUANCE OF STOCK

1. Par Value: a. establishes the corporations "legal capital"

(minimum that must be maintained in SHE)

THIS IS NOT CASH.

b.Protects creditors by limiting the amount ofassets that can be distributed to shareholdersbefore liquidation

c. Par is usuallybelowanticipated selling priceExamples:1. Sold for par: (market price = par)

Example: Sold 1,000 shares at $10 par

2. Sold stock for above Par

Sold 1,000 shares, $1 par for $15/share:


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3. Stock issued for non-cash asset:

Record at FMV of stock traded or FMV of asset received,

whichever is a better indicator of market value.

Exchanged land for 10,000 shares of common stock, $1 par

value. The FMV of the land is $300,000; however, the stock is

traded daily at a selling price of $35 per share.

DIVIDENDS

Distribution of earnings to shareholders

Usually in the form of cash. .

Once board declares a dividend, it becomes a liability

A. Cash Dividends -3 Important Dates

1. Date of declaration - record the liability

2. Date of record - stockholders as of the date of record are

entitled to receive the dividends.

3. Date of payment - record distribution of cash

Effect of Cash Dividends Payment of dividends reduces cash

AND

Retained Earnings are reduced at closing:


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Example:

A corporation has the following shares outstanding:

Preferred Stock (6%) 10,000 shares, $10 par $100,000 at par

Common stock 200,000 shares at $1 par $200,000 at par

The yearly preferred dividend is calculated as$100,000 x 6% = $6,000

Debit Credit

------- --------Retained Earnings 6,000Dividends Payable 6,000

Thus, the preferred stockholders would receive up to the first$6,000 in dividends and common stockholders would receive any dividendsbeyond $6,000.

Stock Dividends

Issue additional shares of common stock equal to worth of dividend. Each

stockholder's % share of ownership remains the same.

Purpose:

A corporation might declare a stock dividend instead of a cash dividend in

order to

1) Increase the number of shares of stock outstanding

2) Move some of its retained earnings to paid-in capital

3) Minimize distributing the corporations cash to its stockholders.


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Effect of Stock Dividend:

1. No effect on Total Stockholder Equity

2. Increases Contributed Capital (increases # shares issued)

3. Decreases Retained Earnings

Example:

ABC Inc. has 10,000 shares of stock outstanding with a par value of $1per share. On December 1, ABC declares a 10% stock dividend to be

distributed on December 21 to stockholders of record on December 10.The market price of the stock on December 1 (the declaration date) is $5per share.

The dividend distributed to the stockholders will be 1,000 shares ofstock (10,000 shares x 10%), so the recorded value of the dividend is$5,000 (1,000 shares x $5 market price per share). The entries torecord the dividend would be as follows:

Debit Credit------- --------

Retained Earnings 5,000Stock Dividends Distributable 1,000Paid-in-Capital in Excess 4,000

Stock Dividends Distributable 1,000Common Stock 1,000

Note that "Stock Dividends Distributable" is not a liability. Itis actually a component of stockholders equity. This isin contrast to dividends payable for cash and property dividends.Dividends payable is a liability.


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STOCK SPLITS

A. Purpose:

1. Decrease market price of stock

2. Increase number of shares outstanding

3. Decrease (split) the par value

Example: Corporation has 20,000 shares, $10 par, market price = $200.

Announce 2-for-l split.

Result: Each shareholder now owns 2 shares of

$5 par for each one share owned prior to split.

Market price now = $100.

Effect of Stock Splits

1. No change in value of corporation

2. No change in total Shareholder Equity

3. No change in Retained Earnings


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TREASURY STOCK

The corporation re-acquires shares of its own stock from stockholders.

Treated as a separate component of Shareholder Equity (reduces

Shareholder Equity on the Balance Sheet)

Reasons to acquire treasury stock:

To reissue the shares to officers and employees under bonus andstock compensation plans.

To increase trading of the company's stock in the securities market inthe hopes of enhancing its market value by signaling thatmanagement believes the stock is underpriced.

To have additional shares available for use in the acquisition of othercompanies.

To reduce the number of shares outstanding and thereby increaseearnings per share.

Treasury stock may be purchased if management is trying toeliminate hostile shareholders by buying them out.

The purchase of treasury stock is generally accounted for by the costmethod.

Under the cost method Treasury Stock is increased (debited) for theprice paid to reacquire the shares. Treasury Stock decreases by thesame amount when the shares are later sold.

The original paid-in capital account, Common Stock, is not affectedbecause the number of issued shares does not change.

Treasury stock is deducted from total paid-in capital and retainedearnings in the stockholders' equity section of the balance sheet


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EXAMPLE

Acquisition of Treasury Stock

When a corporation purchases its own shares in the market with the intentto reissue the shares at a later date, the repurchased shares are known as"Treasury Stock". Treasury stock is recorded at cost with no considerationof par or stated values. The account is a contra-equity account meaningthat it has a debit balance and is shown as a negative component ofstockholders' equity on the balance sheet.

Example:

ABC Inc. purchases 300 shares of its own stock at $5 per share.

Debit Credit------- --------

Treasury Stock 1,500Cash 1,500

Note: Assume that this transaction is ABC's only Treasury stock.This example is continued in the section E on Reissuanceof Treasury Stock.

E. Reissuance of Treasury Stock

If the corporation later reissues the Treasury Stock at more than it costs,the excess is credited to "Paid-in-Capital - Treasury Stock". A corporationcan not show a gain from the sale of its own stock.

Example:

ABC Inc. reissues 100 shares of its Treasury Stock at $7 per share.


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Debit Credit------- --------

Cash 700Treasury Stock (100 shares x $5 cost) 500Paid-in-Capital - Treasury Stock 200

If the corporation later reissues the Treasury Stock at less than its costs, thedeficit is removed from "Paid-in-Capital - Treasury Stock" up to the extentthat any credit balance exists in that account. Any remaining deficit isdebited against "Retained Earnings".

Example:

ABC Inc. reissues the remaining 200 shares of its Treasury Stock at$3 per share.

Debit Credit

------- --------Cash 600Paid-in-Capital - Treasury Stock 200Retained Earnings 200

Treasury Stock (200 shares x $5 cost) 1,000


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CONCEPT OF RETAINED EARNINGS:

Beginning retained earning $ xxxxAdd:

Net income xxxxLess:Stock dividend (xxxx)Cash dividend (xxxx)Total retained earning xxxx

.


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Documents

Stockholder Equity