13-1 corporations: organization and capital stock transactions 13 learning objectives discuss the...

13-1

Corporations: Organization and Capital Stock Transactions13

Learning Objectives

Discuss the major characteristics of a corporation.

Explain how to account for the issuance of common and preferred stock.

Explain how to account for treasury stock.3

2

1

Prepare a stockholders’ equity section.4

13-2

An entity separate and distinct from its owners.

Classified by Purpose

Not-for-Profit

For Profit

Classified by Ownership

Publicly held

Privately held

► McDonald’s► Nike► PepsiCo► Google

► Salvation Army► American Cancer

Society

► Cargill Inc.

Alternative TerminologyPrivately held corporationsare also referred to asclosely held corporations.

LO 1

LEARNINGOBJECTIVE

Discuss the major characteristics of a corporation.

1

13-3

Characteristics that distinguish corporations from

proprietorships and partnerships.

Advantages

Disadvantages

Characteristics of a Corporation

Separate Legal Existence

Limited Liability of Stockholders

Transferable Ownership Rights

Ability to Acquire Capital

Continuous Life

Corporate Management

Government Regulations

Additional Taxes

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13-4

Corporation acts under its own name rather than in the name of its stockholders.








Continuous Life



Additional Taxes

LO 1

13-5

Limited to their investment.








Continuous Life



Additional Taxes

LO 1

13-6

Shareholders may sell their stock.








Continuous Life



Additional Taxes

LO 1

13-7

Corporation can obtain capital through the issuance of stock.








Continuous Life



Additional Taxes

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13-8

Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer.








Continuous Life



Additional Taxes

LO 1

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Separation of ownership and management often reduces an owner’s ability to actively manage the company.

Characteristics that distinguish corporations

from proprietorships and partnerships.






Continuous Life



Additional Taxes

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Continuous Life



Additional Taxes




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Continuous Life



Additional Taxes

Corporations pay income taxes as a separate legal entity and in addition, stockholders pay taxes on cash dividends.

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Stockholders

Chairman and Board of Directors

President andChief Executive

Officer

General Counsel/Secretary

Vice PresidentMarketing

Vice PresidentFinance/Chief

Financial Officer

Vice PresidentOperations

Vice PresidentHuman

Resources

Treasurer Controller

Illustration 13-1 Corporation organization chart


LO 1

13-13

File application with the Secretary of State.

State grants charter.

Corporation develops by-laws.

Initial Steps:

Companies generally incorporate in a state whose laws are

favorable to the corporate form of business (Delaware, New

Jersey).

Corporations engaged in interstate commerce must obtain a

license from each state in which they do business.

Forming a Corporation

Alternative TerminologyThe charter is oftenreferred to as the articlesof incorporation.

LO 1

13-14

A Thousand Millionaires!

Traveling to space or embarking on an expedition to excavate lost Mayan ruins are normally the stuff of adventure novels. But for employees of Facebook, these and other lavish dreams moved closer to reality when the world’s No. 1 online social network went public through an initial public offering (IPO) that may have created at least a thousand millionaires. The IPO was the largest in Internet history, valuing Facebook at over $104 billion. With all these riches to be had, why did Mark Zuckerberg, the founder of Facebook, delay taking his company public? Consider that the main motivation for issuing shares to the public is to raise money so you can grow your business. However, unlike a manufacturer or even an online retailer, Facebook doesn’t need major physical resources, it doesn’t have inventory, and it doesn’t really need much money for marketing. So in the past, the company hasn’t had much need for additional cash beyond what it was already generating on its own. Finally, as head of a closely held, nonpublic company, Zuckerberg was subject to far fewer regulations than a public company.

Source: “Status Update: I’m Rich! Facebook Flotation to Create 1,000 Millionaires Among Company’s Rank and File,” Daily Mail Reporter (February 1, 2012).

Accounting Across the Organization

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13-15

1. Vote in election of board of

directors and on actions that

require stockholder approval.

2. Share the corporate earnings

through receipt of dividends.

Stockholder Rights

LO 1

Illustration 13-3Ownership rights ofstockholders

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3. Keep the same percentage ownership when new shares

of stock are issued (preemptive right).

* A number of companies have eliminated the preemptive right.

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Stockholder Rights


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4. Share in assets upon liquidation in proportion to their

holdings. This is called a residual claim.

LO 1

Stockholder Rights


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When a corporation decides to issue stock, it must

resolve a number of basic questions:

1. How many shares should it authorize for sale?

2. How should it issue the stock?

3. What value should the corporation assign to the

stock?

Stock Issue Considerations

LO 1

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Charter indicates the amount of stock that a corporation

is authorized to sell.

Number of authorized shares is often reported in the

stockholders’ equity section.

No formal accounting entry.

AUTHORIZED STOCK


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Name of corporation

Stockholder’s name

Shares

Signature of corporate official

PrenumberedIllustration 13-4A Stock certificate


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Companies issue common stock directly to investors or

indirectly through an investment banking firm.

Factors in setting price for a new issue of stock:

1. Company’s anticipated future earnings.

2. Expected dividend rate per share.

3. Current financial position.

4. Current state of the economy.

5. Current state of the securities market.

ISSUANCE OF STOCK


LO 1

13-22

Stock of publicly held companies is traded on organized

exchanges.

Interaction between buyers and sellers determines the

prices per share.

Prices tend to follow the trend of a company’s earnings

and dividends.

Factors beyond a company’s control may cause day-to-

day fluctuations in market prices.

MARKET PRICE OF STOCK


LO 1

13-23 LO 1

Investor Insight Nike

13-24

Years ago, par value determined the legal capital per

share that a company must retain in the business for the

protection of corporate creditors.

Today many states do not require a par value.

No-par value stock is fairly common today.

In many states, the board of directors assigns a stated

value to no-par shares.

PAR AND NO-PAR VALUE STOCK


LO 1

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Question

Which of these statements is false?

a. Ownership of common stock gives the owner a voting right.

b. The stockholders’ equity section begins with paid-in capital.

c. The authorization of capital stock does not result in a formal accounting entry.

d. Legal capital is intended to protect stockholders.


LO 1

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Indicate whether each of the following statements is true or false.

______ 1. Similar to partners in a partnership, stockholders of a

corporation have unlimited liability.

______ 2. It is relatively easy for a corporation to obtain capital

through the issuance of stock.

______ 3. The separation of ownership and management is an

advantage of the corporate form of business.

______ 4. The journal entry to record the authorization of capital stock

includes a credit to the appropriate capital stock account.

______ 5. All states require a par value per share for capital stock.

False

True

False

False

False

LO 1

DO IT! Corporate Organization1a

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Paid-in CapitalPaid-in Capital

Retained EarningsAccount


Paid-in Capital in Excess of Par

Account


Account

Two Primary Sources of

Equity

Common StockAccount

Common StockAccount

Preferred StockAccount


Paid-in capital is the total amount of cash and other assets paid in

to the corporation by stockholders in exchange for capital stock.

Corporate Capital

LO 1

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Equity

Common StockAccount

Common StockAccount



Retained earnings is net income that a corporation retains for

future use.

Corporate Capital


Account


Account

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If Delta Robotics has a balance of $800,000 in common stock

and $130,000 in retained earnings at the end of its first year,

its stockholders’ equity section is as follows.

Corporate Capital

Illustration 13-5Stockholders’ equity section

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Comparison of the owners’ equity (stockholders’ equity)

accounts reported on a balance sheet for a proprietorship, a

partnership, and a corporation.

Corporate Capital

LO 1

Illustration 13-6Comparison of owners’ equity accounts

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(a) Income Summary 122,000

Retained Earnings 122,000

(b) Stockholders’ equity

Common Stock $750,000

Retained earnings 122,000

Total stockholders’ equity $872,000

LO 1

DO IT! Corporate Capital1b

At the end of its first year of operation, Doral Corporation has

$750,000 of common stock and net income of $122,000. Prepare

(a) the closing entry for net income and (b) the stockholders’ equity

section at year-end.

Solution

Advance slide in slide show to reveal solution.

13-32 LO 2

Primary Objectives:

1) Identify the specific sources of paid-in capital.

2) Maintain the distinction between paid-in capital and

retained earnings.

Other than consideration received, the issuance of common

stock affects only paid-in capital accounts.

Accounting for Common Stock

LEARNINGOBJECTIVE

Explain how to account for the issuance of common and preferred stock.

2

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b.

Cash 1,000

Common Stock (1,000 x $1) 1,000

Cash 5,000

Common Stock (1,000 x $1) 1,000

Paid-in Capital in Excess of Par —

Common Stock 4,000

Issuing Par Value Common Stock for Cash

Illustration: Assume that Hydro-Slide, Inc. issues 1,000 shares

of $1 par value common stock. Prepare Hydro-Slide’s journal

entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000

shares are issued for $5 per share.

a.

LO 2

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Accounting for Common Stock

Alternative TerminologyPaid-in Capital in Excess of Par is also called Premium on Stock.

LO 2

Illustration 13-7Stockholders’ equity—paid-incapital in excess of par

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Illustration: Assume that instead of $1 par value stock, Hydro-

Slide, Inc. has $5 stated value no-par stock and the company

issues 5,000 shares at $8 per share for cash.

Cash 40,000

Common Stock 25,000

Paid-in Capital in Excess of Stated Value—

Common Stock 15,000

Issuing No-par Common Stock For Cash

LO 2

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Illustration: What happens when no-par stock does not have a

stated value?

Cash 40,000

Common Stock 40,000

LO 2

Issuing No-par Common Stock For Cash

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Corporations also may issue stock for:

Services (attorneys or consultants).

Noncash assets (land, buildings, and equipment).

Cost is either the fair market value of the consideration given up, or the fair market value of the consideration received, whichever is more clearly determinable.

Issuing Common Stock for Services or Noncash Assets

LO 2

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Illustration: Attorneys have helped Jordan Company incorporate.

They have billed the company $5,000 for their services. They agree

to accept 4,000 shares of $1 par value common stock in payment of

their bill. At the time of the exchange, there is no established

market price for the stock. Prepare the journal entry for this

transaction.

Organizational Expense 5,000

Common Stock (4,000 x $1) 4,000

Paid-in Capital in Excess of Par—

Common Stock 1,000

Common Stock for Services

LO 2

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Illustration: Athletic Research Inc. is an existing publicly held

corporation. Its $5 par value stock is actively traded at $8 per

share. The company issues 10,000 shares of stock to acquire land

recently advertised for sale at $90,000. Prepare the journal entry for

this transaction.

Land 80,000

Common Stock (10,000 x $5) 50,000


Common Stock 30,000

LO 2

Common Stock for Noncash Asset

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Typically, preferred stockholders have a priority as to:

1. Distributions of earnings (dividends).

2. Assets in event of liquidation.

Generally do not have voting rights.

Accounting for preferred stock at issuance is similar to that for

common stock.

Accounting for Preferred Stock

LO 2

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Illustration: Stine Corporation issues 10,000 shares of $10

par value preferred stock for $12 cash per share. The journal

entry to record the issuance is:

Preferred stock may have a par value or no-par value.

Accounting for Preferred Stock

Cash 120,000

Preferred Stock (10,000 x $10) 100,000


Preferred Stock 20,000

LO 2

13-42 LO 2

DO IT! Issuance of Stock2

Cayman Corporation begins operations on March 1 by issuing 100,000

shares of $1 par value common stock for cash at $12 per share. On

March 15, it issues 5,000 shares of common stock to attorneys in

settlement of their bill of $50,000 for organization costs. On March 28,

Cayman Corporation issues 1,500 shares of $10 par value preferred

stock for cash at $30 per share. Journalize the issuance of the

common and preferred shares, assuming the shares are not publicly

traded.

Mar. 1Cash 1,200,000

Common Stock (100,000 x $1) 100,000


Common Stock 1,100,000

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traded.

Mar. 15Organization Expense 50,000

Common Stock (5,000 x $1) 5,000


Common Stock 45,000

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traded.

Mar. 28Cash 45,000

Preferred Stock (1,500 x $10) 15,000


Preferred Stock 30,000

13-45





Account


Account

Less:Treasury Stock

Account

Less:Treasury Stock

Account


Equity

Common StockAccount

Common StockAccount



LO 3

LEARNINGOBJECTIVE

Explain how to account for treasury stock.

3

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Treasury stock is a corporation’s own stock that it has

reacquired from shareholders but not retired.

Corporations acquire treasury stock for various reasons:

1. To reissue the shares to officers and employees under

bonus and stock compensation plans.

2. To enhance the stock’s market value.

3. To have additional shares available for use in the acquisition

of other companies.

4. To increase earnings per share.

Accounting for Treasury Stock

LO 3

13-47

Companies generally use the cost method.

Debit Treasury Stock for the price paid to

reacquire the shares.

Treasury stock is a contra stockholders’ equity

account. Reduces stockholders’ equity.

Purchase of Treasury Stock

Helpful Hint Treasury shares do not have dividend rights or voting rights.

LO 3

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Treasury Stock (4,000 x $8) 32,000

Cash 32,000

Illustration: On February 1, 2017, Mead acquires 4,000 shares of

its stock at $8 per share.

Purchase of Treasury StockIllustration 13-8Stockholders’ equity with no treasury stock

LO 3

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Both the number of shares issued (100,000) and the number of shares held as treasury (4,000) are disclosed.

Illustration 13-9Stockholders’ equity with treasury stock

LO 3

Purchase of Treasury Stock

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Sale of Treasury Stock

Above Cost

Below Cost

Both increase total assets and stockholders’ equity.

Disposal of Treasury Stock

Helpful Hint Treasury stock transactions are classified as capital stock transactions. As in the case when stock is issued, the income statement is not involved.

LO 3

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Illustration: On July 1, Mead sells for $10 per share 1,000

shares of its treasury stock previously acquired at $8 per share

and makes the following entry.

Cash 10,000

Treasury Stock 8,000

Paid-in Capital from Treasury Stock 2,000

A corporation does not realize a gain or suffer a loss from

stock transactions with its own stockholders.

SALE OF TREASURY STOCK “ABOVE” COST

LO 3

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Illustration: On Oct. 1, Mead sells an additional 800 shares of

treasury stock at $7 per share and makes the following entry.

Illustration 13-10Treasury stock accounts

SALE OF TREASURY STOCK “BELOW” COST

Cash 5,600

Paid-in Capital from Treasury Stock 800


LO 3

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Cash 15,400


Retained Earnings 1,000


Illustration: On Dec. 1, assume that Mead, Inc. sells its

remaining 2,200 shares at $7 per share and makes the following

entry.

Limited to balance on hand

LO 3

SALE OF TREASURY STOCK “BELOW” COST

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Why Did Reebok Buy Its Own Stock?

In a bold (and some would say risky) move, Reebok at one time bought back nearly a third of its shares. This repurchase of shares dramatically reduced Reebok’s available cash. In fact, the company borrowed significant funds to accomplish the repurchase. In a press release, management stated that it was repurchasing the shares because it believed its stock was severely underpriced. The repurchase of so many shares was meant to signal management’s belief in good future earnings. Skeptics, however, suggested that Reebok’s management was repurchasing shares to make it less likely that another company would acquire Reebok (in which case Reebok’s top managers would likely lose their jobs). By depleting its cash, Reebok became a less attractive acquisition target. Acquiring companies like to purchase companies with large cash balances so they can pay off debt used in the acquisition.

Accounting Across the Organization

LO 3

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July 1 Treasury Stock 180,000

Cash 180,000

Nov. 1 Cash 70,000



LO 3

DO IT! Treasury Stock3

Santa Anita Inc. purchases 3,000 shares of its $50 par value

common stock for $180,000 cash on July 1. It will hold the shares in

the treasury until resold. On November 1, the corporation sells

1,000 shares of treasury stock for cash at $70 per share. Journalize

the treasury stock transactions.

Solution

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Companies report paid-in capital and retained earnings in

the stockholders’ equity section of the balance sheet. Paid-in

capital includes:

1. Capital stock. Preferred stock appears before common stock

because of its preferential rights. Companies report par value,

shares authorized, shares issued, and shares outstanding for

each class of stock.

2. Additional paid-in capital. Excess amounts paid in over par

or stated value and paid-in capital from treasury stock.

LO 4

LEARNINGOBJECTIVE Prepare a stockholder’s equity section4

13-57 LO 4Illustration 13-11Stockholders’ equity section

13-58

Jennifer Corporation has issued 300,000 shares of $3 par value

common stock. It authorized 600,000 shares. The paid-in capital in

excess of par on the common stock is $380,000. The corporation

has reacquired 15,000 shares at a cost of $50,000 and is currently

holding those shares. Treasury stock was reissued in prior years for

$72,000 more than its cost.

The corporation also has 4,000 shares issued and outstanding of

8%, $100 par value preferred stock. It authorized 10,000 shares.

The paid-in capital in excess of par on the preferred stock is

$25,000. Retained earnings is $610,000.

Prepare the stockholders’ equity section of the balance sheet.

LO 4

DO IT! Stockholders’ Equity Section4

13-59 LO 4

13-60

Key Points

Similarities

Aside from the terminology used, the accounting transactions for the issuance of shares and the purchase of treasury stock are similar.

Like GAAP, IFRS does not allow a company to record gains or losses on purchases of its own shares.

LEARNINGOBJECTIVE

Compare the accounting for stockholders’ equity under GAAP and IFRS.

5

LO 5

A Look at IFRS

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Key Points

Differences

Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences.

Many countries have a different mix of investor groups than in the United States. For example, in Germany, financial institutions like banks are not only major creditors of corporations but often are the largest corporate stockholders as well. In the United States, Asia, and the United Kingdom, many companies rely on substantial investment from private investors.

LO 5

A Look at IFRS

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Key Points

There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology.

LO 5

A Look at IFRS

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Key Points

A major difference between IFRS and GAAP relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant, and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital.

IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.

Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and share holders’ funds.

LO 5

A Look at IFRS

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Looking to the Future

The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements.

LO 5

A Look at IFRS

13-65

IFRS Self-Test Questions

Which of the following is true?

a) In the United States, the primary corporate stockholders are

financial institutions.

b) Share capital means total assets under IFRS.

c) The IASB and FASB are presently studying how financial

statement information should be presented.

d) The amount to treasury stock is very different between U.S.

GAAP and IFRS.

LO 5

A Look at IFRS

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A Look at IFRS


Under IFRS, the amount of capital received in excess of par

value would be credited to:

a) Retained Earnings.

b) Contributed Capital.

c) Share Premium.

d) Par value is not used under IFRS.

LO 5

A Look at IFRS

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Which of the following does not represent a pair of GAAP/IFRS-

comparable terms?

a) Additional paid-in capital/Share premium.

b) Treasury stock/Repurchase reserve.

c) Common stock/Share capital.

d) Preferred stock/Preference shares.


LO 5

A Look at IFRS

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13-1 corporations: organization and capital stock transactions 13 learning objectives discuss the...

Documents

major characteristics

separation of ownership

issuance of stock

corporation acts

preferred stock

treasury stock

financial accounting

owners ability