Corporations: Organization, Capital Stock Transactions, and Dividends

Instructor’s Lecture

P.H.

Characteristics of a Corporation

a legal entity, separate from its owners (stockholders)

limited liability– a stockholder’s loss is limited to his/her

investment subject to double taxation

– the corporation pays taxes on earnings– the stockholder pays taxes on dividends

received

Organizational Structure of a Corporation

Stockholders

Board of Directors

Officers

Employees

elect

selects

hire

Owner’s Equity in a Corporation

is called Stockholders’ Equity, Shareholders’ Equity, Shareholders’ Investment, or Capital

consists of two main sources:1. paid-in capital (also called contributed

capital)

2. retained earnings

Stockholders’ Equity:

1. Paid-in capital is capital contributed to the corporation by the stockholders

2. Retained earnings is net income earned by the corporation and retained (kept) in the business (not distributed to the stockholders in the form of dividends)

Stockholders’ Equity: Paid-in Capital Paid-in capital is recorded in separate

accounts for each class of stock, for example, common stock and preferred stock

If there is only one class of stock, it is called Common Stock, or Capital Stock

Stockholders’ Equity: Retained Earnings

Net income or net loss is closed to the Retained Earnings account at the end of the period

The Dividends account (similar to the Drawing account) is also closed the Retained Earnings account

Stockholders’ Equity: Retained Earnings

Retained earnings is accumulated net income

– net income increases retained earnings– dividends decrease retained earnings

Stockholders’ Equity: Retained Earnings

Retained earnings may also be called earnings retained for use in the business, or earnings reinvested in the business

The normal balance of the Retained Earnings account is credit (remember, it is an owners’ equity account)

A debit balance in the Retained Earnings account is called a deficit, and is the result of accumulated net losses

Stockholders’ Equity: Retained Earnings

A deficit is deducted from paid-in capital to determine total stockholders’ equity

Just as net income does not represent cash available, retained earnings does not represent surplus cash

Stockholders’ Equity: Sources of Paid-In Capital

Stock Donations of real estate or other assets

Stockholders’ Equity: Sources of Paid-In Capital

Stock Authorized

– stated in the charter of the corporation Issued

– shares issued (sold) to the stockholders Outstanding

– stock remaining in the hands of the stockholders

– shares that receive dividends

Stockholders’ Equity: Sources of Paid-In Capital

Classes of Stock Common Stock

– when there is only one class of stock it is “common stock”

Preferred Stock– nonparticipating vs. participating

• most preferred stock is nonparticipating

– cumulative vs. non-cumulative• cumulative preferred stock has the right to receive regular

dividends that have been passed (are in arrears) before any common stock dividends are paid

Stockholders’ Equity: Sources of Paid-In Capital

Preferred Stock

Has preference over common stockholders in receiving dividends

Has preference over common stockholders in receiving assets on liquidation

Stockholders’ Equity: Sources of Paid-In Capital

Rights of Stockholders

1. The right to vote

2. The right to share in distributions of earnings (dividends)

3. The right to share in assets on liquidation (the winding up of a corporation when it goes out of business)

Stockholders’ Equity: Sources of Paid-In Capital

Terms Par Value

– a monetary amount that may be assigned to a share of stock

– related to legal capital (a minimum amount of stockholder contribution that a corporation may be required to retain for the protection of its creditors)

Stated Value– some states may require a corporation to assign a stated

value to no-par stock

Stockholders’ Equity: Sources of Paid-In Capital

Issuing (Selling) Stock at Par

Cash 1,500,000

Preferred Stock 500,000

Common Stock 1,000,000

Stockholders’ Equity: Sources of Paid-In Capital

Issuing (Selling) Stock at a Premium

Cash 110,000

Preferred Stock 100,000

Paid-In Capital in Excess of Par-Preferred Stock*

10,000

*When stock is issued at a price that is above par, a separate account is credited for the amount above par

Stockholders’ Equity: Sources of Paid-In Capital

Issuing (Selling) Stock With a Stated Value at a Premium

Cash 400,000

Common Stock 250,000

Paid-In Capital in Excess of Stated Value*

150,000

*When no-par stock that has been assigned a stated value is issued at a price that is above par, a separate account is credited for the amount above par

Stockholders’ Equity Treasury Stock

Treasury stock is shares of its own stock that a corporation has once issued and then reacquires

The number of shares issued and the number of shares outstanding will be different if the corporation holds treasury stock

Shares held in the treasury do not receive dividends

Treasury stock reduces total stockholder’s equity

Stockholders’ EquityReasons for Purchasing Treasury

Stock

1. For resale to employees

2. To reissue as a bonus to employees

3. To support (boost) the market price of the stock

Stockholders’ EquityTreasury Stock

Follow the transactions and corresponding journal entries for treasury stock in your text

Use T-accounts to post to the Treasury Stock and Paid-In Capital from Sale of Treasury Stock accounts, and keep track of the number of shares of treasury stock as you do your homework

Stock Splits

A reduction in the par or stated value of a share of common stock, and the issuance of a proportionate number of additional shares

Applies to all shares, including unissued, issued, and treasury shares

Stock Splits

A stock split does not change the total dollar amount of common stock outstanding; only the par value per share and the number of shares is changed

A stock split does not require a journal entry—the details are disclosed in the notes to the financial statements

A stock split does not change the proportional ownership in the corporation for an individual stockholder

Stock SplitsIllustrated

Assume that a corporation has 10,000 shares of $100 par value common stock outstanding with a market price of $120 per share. The board of directors declares a 4-for-1 stock split. What is the new par value per share, the new total number of shares outstanding, and the the total dollar amount of common stock outstanding after the split?

Stock SplitsIllustrated

before the split after the split

par value per share

$100 $25

($100/4)

# of shares outstanding

10,000 40,000 (10,000 shares x 4)

total dollar amount of common stock outstanding

$1,000,000 ($100/share x 10,000 shares)

$1,000,000 ($25/share x

40,000 shares)

Stock SplitsIllustrated

The proportional ownership in the corporation does not change for an individual stockholder. Let’s say a stockholder has 100 shares before the split:

% ownership before the split:

% ownership after the split:

100 shares/10,000 shares = 10%

400 shares/ 40,000 shares = 10%

Stock SplitsIllustrated

What would you expect the market price per share to change to?

Stock SplitsIllustrated

Did you get $30?*

*$120/4

Accounting for DividendsConditions for a Cash Dividend

1. Sufficient retained earnings declaration of a dividend reduces retained

earnings

2. Sufficient cash

3. Formal action by the board of directors

Accounting for DividendsImportant Dates

1. Date of declaration2. Date of record

determines who gets the dividend

3. Date of payment

Journal entries are required for the date of declaration and the date of payment

Accounting for DividendsCash Dividends

Dec. 1 Cash Dividends 42,500

Cash Dividends Payable 42,500

Declared cash dividend

Jan. 2 Cash Dividends Payable 42,500

Cash 42,500

Paid cash dividend

Accounting for DividendsStock Dividends

Assume the following information for a corporation:

Common Stock, $10 par (200,000 shares issued)

On Dec. 15, the board of directors declares a stock dividend of 2% (4,000 shares) to be issued on Jan. 10 to stockholders of record on Dec. 31. The market price of the stock on Dec. 15 is $15 a share.

Accounting for DividendsStock Dividends

Dec. 15 Stock Dividends* 60,000

Stock Dividends Distributable** 40,000

Paid-in Cap. in Excess of Par 20,000

Declared stock dividend

Jan. 10 Stock Dividends Distributable 40,000

Common Stock 40,000

Issued stock

*4,000 shares x $15/share (market price per share on Dec. 15)

**4,000 shares x 10 share (par value)

Accounting for DividendsStock Dividends

A stock dividend does not change the assets, liabilities, or total stockholders’ equity of the corporation. It also does not change the proportional ownership in the corporation for an individual stockholder.

Financial Analysis and InterpretationDividend Yield

Indicates the rate of return to stockholders in terms of cash dividend distributions:

Dividends per share of Common Stock

Market Price per share of Common StockDividend Yield

The dividend yield is of special interest to stockholders whose main objective is to receive a current cash return on their investment

Chapter 12: New Accounts

Account Category Normal

Balance

Common Stock S/E Credit

Preferred Stock S/E Credit

Paid-in Capital in Excess of Par/Stated Value S/E Credit

Retained Earnings S/E Credit

Donated Capital S/E Credit

Treasury Stock S/E Debit

Paid-in Capital from Sale of Treasury Stock S/E Credit

Cash Dividends (temporary account) S/E Debit

Cash Dividends Payable Liability Credit

Stock Dividends (temporary account) S/E Debit

Stock Dividends Distributable S/E Credit