©coursecollege.com 1 23 corporations learning objectives 1.identify characteristics of a...

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23 Corporations

ProfitDebit Credit or

Loss

Expenses

BALANCE SHEET INCOME STATEMENT

Assets Liabilities Revenue

Equity

Learning Objectives

1. Identify characteristics of a corporation

2. Account for organizing a corporation

3. Account for cash dividends

4. Describe the structure of bonds, their issuance and interest payments

5. Analysis: Compute and explain return on common stockholder’s equity

A review of the Equity section of

the balance sheet will

indicate the corporate form of

business organization

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Corporations

Some of the disadvantages and advantages to the corporate form

Disadvantages•double taxation•the cost to organize and maintain

Advantages •Limited liability of owners •Unlimited life of corporations•Ease of transfer of equity and capital formation

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Objective 23.1: Identify characteristics of a

corporation

O23.1

A corporation is an entity created by law at a state level. It has a separate identity from its owners and has most of the rights and privileges of individuals.

Accounting for corporations differs from proprietorships and partnerships in the way the equity section is organized.

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Corporate organization

Stockholders(Owners)

ELECT Board of Directors(Directors)

APPOINTCorporate Officers

(Managers)

MANAGE

Employees

O23.1

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Corporate classification

Public corporations are owned by or related to governmental units (i.e. Tennessee Valley Authority, Port of Seattle).

Private corporations are privately owned either (non stock) or not-for-profit organizations or for profit stock issuing organizations (i.e. Ford, Exxon, GE).

Who Owns the

Corporation?

O23.1

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Open & owned by the public with stock available for purchase generally listed for sale by one of the national or regional stock exchanges. Often called publicly traded corporations.

Closed, ownership held by a few stockholders with stock not available for purchase by the general public.

Who Can become an

Owner?

O23.1

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Domestic when operating in the state where the corporation was originally incorporated.

Foreign when legally operating in states other than the state in which it was incorporated.

Where is the

Corporation from?

O23.1

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Corporate overview

O23.1

Limited Liability

Owners and managers are not liable for corporate debt

Creditors can seek and obtain owner and manager liability by separate agreement

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Corporate overview

O23.1

Restricted Agency

Owners cannot act as agents for the corporationOnly authorized corporate officers and employees can act to bind the corporation Major corporate decisions may require board of directors approval

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Corporate overview

O23.1

Unlimited Life

Corporations are legal entities with potential unlimited life

Maintenance of state level reporting and registering requirements is necessary to maintain corporation

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Corporate overview

O23.1

Income tax

Corporations are taxable entities

Corporations pay income taxes based on graduated scales

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Stock Ownership

Common stockholders have the following rights:

To vote at stockholders’ meeting. In particular to elect members of the board of directors

To sell or transfer their stock ownership to others

To share in earnings To purchase additional shares if more

shares are issued by the corporation.After creditors have been paid, to share

in the assets of the corporation if it is liquidated

O23.1

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Corporate shares of stock

O23.1

Authorized SharesAuthorized Shares

Issued SharesIssued Shares

OutstandingShares

OutstandingShares

•Corporate charters indicate the number of shares of stock that the corporation is authorized to sell. •If any of the authorized stock is sold, it is referred to as issued. •While issued stock is still in circulation it is referred to as outstanding. •Stock can be issued and not outstanding* if the corporation repurchases the shares of stock and holds them as treasury stock.•Repurchased shares may also be retired

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Corporate Equity -comparison

EQUITY

T. Pope, Capital 50,000

T. Pope, Drawing (3,000)Total Equity 47,000

EQUITY

T. Pope, Capital 50,000

T. Pope, Drawing (3,000)Total Equity 47,000

Proprietorship

EQUITYT. Boss, Capital 40,000

T. Boss, Drawing (1,000)

M.West, Capital 60,000M.West, Drawing (3,000)

Total Equity 96,000

EQUITYT. Boss, Capital 40,000

T. Boss, Drawing (1,000)

M.West, Capital 60,000M.West, Drawing (3,000)

Total Equity 96,000

Partnership

EQUITYCommon Stock 50,000 (no par value)

Retaind Earnings 62,000Total Equity 112,000

EQUITYCommon Stock 50,000 (no par value)

Retaind Earnings 62,000Total Equity 112,000

Corporation


Loss

Expenses



Equity

O23.1

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Preferred & common shares of stock

O23.1

Corporations may issue:

•Common shares -the basic type of stock

•Preferred shares -with special rights and privileges

•More than one class of both common and preferred stock

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Preferred stock

O23.1

•Typically is offered without the right to vote. This arrangement evolved to allow corporations raise capital without diminishing the control structure held by existing common stockholders

•Normally has a stated dividend rate

•Preferred stockholders receive a preference for any cash dividends

•Preferred stockholders receive a preference over common stockholders in the event of liquidation (not over creditors)

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Preferred cash dividend preference

O23.1

Common Stockholders Preferred Stockholders

Cash Dividends Paid Here

I‘m sorry, you’ll have to wait here until

the preferred

stockholders get paid.

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Par value stock•When incorporating, par value stock may be issued

•Par value is a dollar amount of value assigned arbitrarily to each share of stock. This par value has no effect on what price the stock will sell for now or in the future

•Most states also now permit no par value stock to be issued

•No par value stock sometimes is assigned a value after the initial stock sale, it is referred to as stated value stock

O23.1

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Minimum legal capital

•States typically require corporations to establish and to some extent, maintain what is called minimum legal capital

•This is the total dollar amount of equity that must be raised per the charter authorization. Unless it is in liquidation, the corporation is required in most states to maintain this minimum legal capital for the protection of creditors

•The corporation may not distribute assets to stockholders if the result would be to lower the equity level below the minimum legal capital required

•Usually the par value times the minimum number of shares required to be sold initially under the charter becomes the minimum legal capital. In the case of no par value stock, the entire proceeds from the initial sale of stock becomes the minimum legal capital

O23.1

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Sale of par value stock

O23.1

EQUITYCommon Stock at Par 5,000(1,000 shares @ $5)

Contributed Capital in Excess of Par 30,000

Retained Earnings 62,000Total Equity 97,000




CorporationWhen par value stock is sold, the market price per share rarely, if ever, equals the par value. The equity accounts established in the corporate equity section must maintain the par values. Therefore, two separate accounts are used:

1)Common Stock at Par and 2)Contributed Capital in Excess of Par.

Together, these two accounts are commonly referred to as paid-in or contributed capital.

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Contributed capital & Retained Earnings

O23.1







Corporation

To distinguish the equity provided by investors from the equity which may be

earned by the corporation, earned corporate equity is

recorded in a special account, unique to corporations called retained earnings

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Contributed capital & Retained Earnings

O23.1







Corporation

The Retained Earnings account holds the

accumulated (year after year) total of earnings

achieved by the corporation that were retained. That is, they

were not returned to the stockholders as dividends

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Objective 23.2: Account for organizing a corporation

O23.2

Western Corporation is in the process of formationand sells 500 shares of stock at $10 par value

Page 1

Date Description PR Debit Credit

10/1/11 Cash 1000 5,000

Common Stock, $10 par value 3100 5,000

GENERAL JOURNAL


Loss

Expenses



Equity

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Stock sold for more than par value

O23.2

Western Corporation subsequently sells 1000shares for $15 per share ($10 par value)

Page 1


11/15/11 Cash 1000 15,000

Common Stock, $10 par value 3100 10,000

Contributed Capital in Excess

of Par, Common Stock 3115 5,000

GENERAL JOURNAL


Loss

Expenses



Equity

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Resulting corporate equity

STOCKHOLDER EQUITYCommon Stock at Par 15,000(1,500 shares @ $10 par value)

Contributed Capital in Excess of Par, Common Stock 5,000

Retained Earnings 0Total Equity 20,000

STOCKHOLDER EQUITYCommon Stock at Par 15,000(1,500 shares @ $10 par value)



Western Corporation

Contributed Capital

O23.2

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Sale of no par stock

O23.2

Eastern Corporation is in the process of formationand sells 1500 shares of no par stock

for $20 per share

Page 1


10/1/11 Cash 1000 30,000

Common Stock, no par value 3100 30,000

GENERAL JOURNAL


Loss

Expenses



Equity

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Sale of no par stock

O23.2

Subsequently, Eastern Corporation sells2500 shares of no par stock

for $22 per share

Page 1


11/1/11 Cash 1000 55,000


GENERAL JOURNAL


Loss

Expenses



Equity

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STOCKHOLDER EQUITYCommon Stock 85,000(4,000 shares no par value)




Eastern Corporation

Contributed Capital

O23.2

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Investment of assets other than cash

O23.2

Eastern Corporation accepts equipment with amarket value of $110,000 and issues the

investor shares based on the most recent marketprice of $22 per share (110,000/22 = 5,000 shares)

Page 1


12/2/11 Equipment 1500 110,000


GENERAL JOURNAL


Loss

Expenses



Equity

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Eastern Corporation

Contributed Capital

O23.2

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Closing net income for a corporation

O23.2

Eastern Corporation completes its’ first year of operations with net income of $75,000

which is closed to Retained Earnings


Loss

Expenses



Equity

Page 1


12/31/11 Income Summary 3900 75,000

Retained Earnings 3400 75,000

GENERAL JOURNAL

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Eastern Corporation

Contributed

Capital+

Retained Earnings

O23.2

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Sale of preferred stock

O23.2

Western Corporation needs additional capital.50 shares of $100 par 7% preferred stock are

sold for $125 per share

Page 1


12/15/11 Cash 1000 6,250

Preferred Stock, $100 par value 3600 5,000

Contributed Capital in Excess

of Par, Preferred Stock 3615 1,250

GENERAL JOURNAL


Loss

Expenses



Equity

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STOCKHOLDER EQUITYPreferred Stock at Par 5,000

(50 shares @ $100 par value)Contributed Capital in Excess of Par, Preferred Stock 1,250

Common Stock at Par 15,000(1,500 shares @ $10 par value)



STOCKHOLDER EQUITYPreferred Stock at Par 5,000

(50 shares @ $100 par value)Contributed Capital in Excess of Par, Preferred Stock 1,250

Common Stock at Par 15,000(1,500 shares @ $10 par value)



Western Corporation

Contributed

Capital

O23.2

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Objective 23.3: Account for cash dividends

O23.3

Cash dividends•Cash is paid to stockholders •Must be approved by the board of directors•Are not guaranteed to stockholders•Are optional distributions of cash •Are declared if the board believes the current financial condition and availability of cash warrants the distribution under the goals of the firm


Loss

Expenses



Equity

Stockholders

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Dividend declaration

O23.3

Eastern Corporation board of directorsdeclares a $25,000 cash dividend on January 31


Loss

Expenses



Equity

Page 1


1/31/12 Retained Earnings 3400 25,000

Dividends Payable 2850 25,000

GENERAL JOURNAL

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Eastern Corporation 75,000-25,000 = 50,000

O23.3


Loss

Expenses



Equity25,000 moved from Equity to Liabilities

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Date of record

O23.3

Eastern Corporation’s cash dividend will be paidto those stockholders who own stock on March 1.


Loss

Expenses



Equity

Page 1


GENERAL JOURNAL

No journal entry is made on the date of

record

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Date of payment

O23.3

Eastern Corporation’s $25,000 cash dividend is paid on March 15


Loss

Expenses



Equity

Page 1


3/15/12 Dividends Payable 2850 25,000

Cash 1000 25,000

GENERAL JOURNAL

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Preferred stock dividend preference

O23.1

•Cumulative –preferred dividends not paid in any year must be paid first in subsequent years from any cash dividends declared

•Non-cumulative –if no preferred dividends are paid, there is no right to receive the missed dividend in the future

•Participating –(rare) after receiving preferred dividends, preferred stockholders join common stockholders to share in remaining cash dividends (specifics of the sharing agreement specified in original preferred stock agreement)

•Non-participating –after receiving preferred dividends, preferred stockholders have no right to participate in remaining dividends with common stockholders

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Dividend allocation

STOCKHOLDER EQUITYPreferred Stock at Par 9% dividend 500,000

(5000 shares @ $100 par value)Contributed Capital in Excess of Par, Preferred Stock 0

Common Stock at Par 1,500,000(150,000 shares @ $10 par value)


Retained Earnings 750,000Total Equity 3,050,000

STOCKHOLDER EQUITYPreferred Stock at Par 9% dividend 500,000

(5000 shares @ $100 par value)Contributed Capital in Excess of Par, Preferred Stock 0

Common Stock at Par 1,500,000(150,000 shares @ $10 par value)


Retained Earnings 750,000Total Equity 3,050,000

ArticAir Corporation ArticAir has 9%

cumulative and non-

participating preferred

O23.3

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Dividend allocation

O23.2

ArticAir Corporation Board of directors declaresa $100,000 cash dividend on January 31


Loss

Expenses



Equity

Preferred 500,000 at par x 9% = 45,000 to preferred and the balance of 55,000 to common stockholders.

Page 1



Preferred Dividend Payable 2610 45,000

Common Dividend Payable 2620 55,000

GENERAL JOURNAL

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Dividend allocation –preferred in arrears

O23.3

For the following year 2012, ArticAir declared no dividends. For 2013, $100,000 cash dividends are

declared on 1/31/14.


Loss

Expenses



Equity

Preferred 500,000 at par x 9% = 45,000 to preferred for 2012 plus 45,000 for the current year 2013 with the balance of 10,000 to common stockholders.

Page 1



Preferred Dividend Payable 2610 90,000

Common Dividend Payable 2620 10,000

GENERAL JOURNAL

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Additional preferred stock features

O23.3

Convertible preferred stock allows stockholders to convert their shares into a predetermined number of common shares. These rights typically have a time window in which they must be executed.

Call features allow the issuing firm to retire (repurchase) and replace the issued preferred stock Call provisions usually carry a call price, a premium above the par value that must be paid by the issuer.

Convertible preferred stock allows stockholders to convert their shares into a predetermined number of common shares. These rights typically have a time window in which they must be executed.

Call features allow the issuing firm to retire (repurchase) and replace the issued preferred stock Call provisions usually carry a call price, a premium above the par value that must be paid by the issuer.

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Objective 23.5: Analysis: Compute and explain return on common stockholder’s

equity


Loss

Expenses



Equity

Compares earnings

available to common

stockholders to the

average amount of common equity

O23.5

Investors are especially interested inthis ratio which compare earnings

to average common stockholder’s equity.

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Return on common stockholders equity

Earnings available to common stockholders = net income minus preferred stockholder dividends.

The higher the return, the more desireable the

common stock within the risk profile

presented by the firmO23.5

Return on common

stockholder’s equity Average common

stockholder’s equity

Net income – preferred dividends=

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Example

O23.5

Assets 2010 2011 Liabilities 2010 2011 Cash 40,000 56,800 Total liabilities 380,000 325,400

Accounts receivable 193,200 235,400 EquityInventory 256,400 213,900 Common Stock -No par 240,000 260,000Property, Plant, Equip. 575,400 584,300 Preferred Stock -No par 80,000 80,000

Retained Earnings 365,000 425,000 Total assets 1,065,000 1,090,400 Total liab. + equity 1,065,000 1,090,400

Preferred dividend 10%

Cumulative & nonparticipating - none in arrears

Sales 3,457,600 Preferred dividend 8,000(10% x $80,000 Preferred Stock)

Cost of Goods Sold 2,593,200 Avg. Common Stockholder Equity 250,000Wages expense 305,200 (Equity for years 2010 +2011) / 2Sellling expenses 136,500 Return on CommonAdministrative exp. 235,800 Stockholders Equity 20.8%Miscellaneous exp. 126,900 (NI - Preferred Dividend)/ Avg Equity

Net Profit 60,000

Balance Sheet -TorxTech CorporationAs of 12/31 2010 and 2011

Income StatementFor the year ended 12/31/11

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