Accounting for Corporations

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Accounting for Corporations
Chapter
13
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Learning objectives

• Identify characteristics of corporations and
  their organization.
• Describe the components of stockholders equity.
• Explain characteristics of common and preferred
  stock.
• Explain the form and content of a complete income
  statement.
• Explain the items reported in retained earnings.
• Record the issuance of corporate stock.
• Distribute dividends between common stock and
  preferred stock.
• Record transactions involving cash dividends.
• Account for stock dividends and stock splits.
• Record purchases and sales of treasury stock and
  the retirement of stock.

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Corporate Form of Organization
An entity created by law.
Privately Held
Existence is separate from owners.
Has rights and privileges.
Publicly Held
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Characteristics of Corporations

• Advantages
• Separate Legal Entity
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Continuous Life
• Stockholders Are Not Corporate Agents
• Ease of Capital Accumulation
• Disadvantages
• Governmental Regulation
• Corporate Taxation

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Organizing and Managing a Corporation
Stockholders
Board of Directors
President, Vice-President, and Other Officers
Employees of the Corporation
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Organizing and Managing a Corporation
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Rights of Stockholders

• Vote at stockholders meetings.
• Sell stock.
• Purchase additional shares of stock.
• Receive dividends, if any.
• Share equally in any assets remaining after
  creditors are paid in a liquidation.

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Stock Certificates and Transfer
When the stock is sold, the stockholder signs a
transfer endorsement on the back of the stock
certificate.
Each unit of ownership is called a share of
stock. A stock certificate serves as proof that a
stockholder has purchased shares.
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Basics of Capital Stock
Total amount of stock that a corporations
charter authorizes it to sell.
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Basics of Capital Stock
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Selling (Issuing) Stock
?
Par value is an arbitrary amount assigned to each
share of stock when it is authorized.
Market price is the amount that each share of
stock will sell for in the market.
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Issuing Par Value Stock
Par Value Stock On September 1, Matrix, Inc.
issued 100,000 shares of 2 par value stock for
25 per share. Lets record this transaction.

• Record
• The cash received.
• The number of shares issued the par value per
  share in the Common Stock account.
• The remainder is assigned to Contributed Capital
  in Excess of Par.

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Issuing Par Value Stock
Par Value Stock On September 1, Matrix, Inc.
issued 100,000 shares of 2 par value stock for
25 per share. Lets record this transaction.
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Issuing Par Value Stock
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Issuing Stock for Noncash Assets
Par Value Stock On September 1, Matrix, Inc.
issued 100,000 shares of 2 par value stock for
land valued at 2,500,000. Lets record this
transaction.

• Record
• The asset received at its market value.
• The number of shares issued the par value per
  share in the Common Stock account.
• The remainder is assigned to Contributed Capital
  in Excess of Par.

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Issuing Stock for Noncash Assets
Par Value Stock On September 1, Matrix, Inc.
issued 100,000 shares of 2 par value stock for
land valued at 2,500,000. Lets record this
transaction.
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Preferred Stock

• A separate class of stock, typically having
  priority over common shares in . . .
• Dividend distributions.
• Distribution of assets in case of liquidation.

Usually has a stated dividend rate.
Normally has no voting rights.
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Preferred Stock

• Dillon Snowboards issues 50 shares of 100 par
  value preferred stock for 6,000 cash on July 1,
  2005.
• Dr. Cash
  6,000
• Cr. Preferred Stock, 100 par value
  5,000
• Cr. Contributed Capital in Excess
• of par value, preferred stock
  1,000

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Reasons for Issuing Preferred Stock

• To raise capital without sacrificing control.
• To appeal to investors who may believe the common
  stock is too risky or that the expected return on
  common stock is too low.

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Cash Dividends

• To pay a cash dividend the corporation must
  have
• A sufficient balance in retained earnings and
• The cash necessary to pay the dividend.

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Cash Dividends

• Regular cash dividends provide a return to
  investors and almost always affect the stocks
  market value.

Stockholders
Dividends
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Entries for Cash Dividends

• Three important dates

Dividends
Date of Declaration
Date of Record
Date of Payment
Record liability for dividend.
No entry required.
Record payment of cash to stockholders.
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Entries for Cash Dividends

• On January 19, a 1 per share cash dividend is
  declared on Dana, Inc.s 10,000 common shares
  outstanding. The dividend will be paid on March
  19 to stockholders of record on February 19.

Dividends
Date of Declaration
Record liability for dividend.
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Entries for Cash Dividends

• On January 19, a 1 per share cash dividend is
  declared on Dana, Inc.s 10,000 common shares
  outstanding. The dividend will be paid on March
  19 to stockholders of record on February 19.

No entry required on February 19.
Date of Record
No entry required.
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Entries for Cash Dividends

• On January 19, a 1 per share cash dividend is
  declared on Dana, Inc.s 10,000 common shares
  outstanding. The dividend will be paid on March
  19 to stockholders of record on February 19.

Date of Payment
Record payment of cash to stockholders.
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Deficits and Cash Dividends

• Created when a company incurs cumulative losses
  or pays dividends greater than total profits
  earned in other years.

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Stock Dividends

• The corporation distributes additional shares of
  its own stock to its stockholders without
  receiving any payment in return.

• Why a stock dividend?
• Can be used to keep the market
• price on the stock affordable.
• Can provide evidence of
• managements confidence that
• the company is doing well.

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Stock Dividends

• A company has 1,000 common shares outstanding.
  Market price is 12. The company announces a 20
  stock dividend. The market price will be 10.
  However, due to the expectation of future more
  cash dividend, the market price may increase to
  10.5 or so.

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Stock Dividends

• Small Stock Dividend
• Distribution is 25 of the previously
  outstanding shares.
• Capitalize retained earnings for the market value
  of the shares to be distributed.

• Large Stock Dividend
• Distribution is gt 25 of the previously
  outstanding shares.
• Capitalize retained earnings for the minimum
  amount required by state law, usually par or
  stated value of the shares.

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Recording a Small Stock Dividend

• Here is the stockholders equity section of
  Quests balance sheet prior to the declaration of
  a small stock dividend.

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Recording a Small Stock Dividend

• On December 31, 2005, Quest declared a 2 stock
  dividend, when the stock was selling for 10 per
  share. The stock will be distributed to
  stockholders on January 20, 2006. Lets make the
  December 31 entry.

100,000 2 2,000 10 20,000/
10000.022000shares 2,000 1 par
2,000/20001020000RE, 200012000
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Before the stock dividend.
After the stock dividend.
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Recording a Large Stock Dividend

• Router, Inc. shows the following stockholders
  equity section just prior to issuing a large
  stock dividend.

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Recording a Large Stock Dividend

• On December 31, 2005, Router declared a 40 stock
  dividend, when the stock was selling for 8 per
  share. State law requires that large stock
  dividends be capitalized at par value per share.

50,000 40 20,000 shares 1 par value
20,000
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Stock Splits

• A distribution of additional shares of stock to
  stockholders according to their percent ownership.

10 par value
Old Shares
Common Stock
100 shares
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Stock Splits

• Thomas, Inc. has the following stockholders
  equity section just prior to a 2-for-1 stock
  split.

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Stock Splits

• After the 2-for-1 split the stockholders equity
  section of the balance sheet looks like this . . .

No accounting entry is made.
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Stock Splits

• The split does not affect any equity amounts
  reported on balance sheet or any individual
  stockholders percent ownership. Both the
  contributed capital and retained earnings
  accounts are unchanged by a split.

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Treasury Stock

• Corporations acquire shares of their own stock.

• Use the shares to acquirecontrol of another
  corporation.
• To avoid a hostile takeover.
• Use the shares foremployee stock options.
• To maintain a strong market forits stock or show
  managementconfidence in the current price.

Why would a company do that?
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Treasury Stock
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Purchasing Treasury Stock

• On May 8, Whitt, Inc. purchased 2,000 of its own
  shares of stock in the open market for 8,000.

Treasury stock is shown as a reduction in
total stockholders equity on the balance sheet.
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Selling Treasury Stock at Cost

• On June 30, Whitt sold 100 shares of its treasury
  stock for 4 per share.

8,000 2,000 shares 4 cost per treasury share
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Selling Treasury Stock Above Cost

• On July 19, Whitt, Inc. sold an additional 500
  shares of its treasury stock for 8 per share.

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Selling Treasury Stock Below Cost

• On August 27, Whitt sold an additional 400 shares
  of its treasury stock for 1.50 per share.

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Reporting Income and Equity
Extraordinary Items
Changes in Accounting Principle
Discontinued Segments
Net Income
Continuing Operations
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Continuing Operations
Revenues, expenses and income generated by the
companys continuing operations.
Net Income
Continuing Operations
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Discontinued Segments
Income from operating the discontinued segment
prior to its disposal and gain or loss on the
sale of the net assets of the segment.
Discontinued Segments
Net Income
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Extraordinary Items
Extraordinary Items
A gain or loss that is unusual in nature and
infrequent in occurrence.
Net Income
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Changes in Accounting Principles
The increase or decrease in income when changing
from one generally accepted accounting principle
to another.
Changes in Accounting Principle
Net Income
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Income Statement
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Earnings Per Share

• Earnings per share is one of the most widely
  cited items of accounting information.

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Changes in Shares Outstanding

• Derby, Inc. reports net income of 75,000 and
  paid preferred dividends of 10,000 during 2005.
  The company started the year with 10,000 shares
  of common stock outstanding. Derby sold an
  additional 4,000 share of stock on March 31, and
  purchased 2,000 treasury shares on September 30,
  2005.

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Changes in Shares Outstanding

• Derby, Inc. reports net income of 75,000 and
  paid preferred dividends of 10,000 during 2005.
  The company started the year with 10,000 shares
  of common stock outstanding. Derby sold an
  additional 4,000 share of stock on March 31, and
  purchased 2,000 treasury shares on September 30,
  2005.

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Stock Options

• The right to purchase common stock at a fixed
  price over a specified period of time. As the
  stocks price rises above the fixed option price,
  the value of the option increases.

Market price of stock 75 per share.
Option purchase price 30 per share.
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Stock Options

• Options are given to key employees to motivate
  them to
• focus on company performance,
• take a long-run perspective, and
• remain with the company.

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Statement of Retained Earnings

• Total cumulative amount of reported net income
  less any net losses and dividends declared since
  the company started operating.

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Restricted Retained Earnings
Legal
Contractual
Most states restrict the amount of treasury
stock purchases to the amount of
retained earnings.
Loan agreements can include restrictions on
paying dividends below a certain amount
of retained earnings.
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Appropriated Retained Earnings

• A corporations directors can voluntarily limit
  dividends because of a special need for cash such
  as the purchase of new facilities.

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Prior Period Adjustments

• Correction of material errors in past years
  financial statements. If an amount is incorrectly
  expensed, add amount to Retained Earnings.

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Statement of Stockholders Equity
This is a more inclusive statement than the
statement of retained earnings.
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Book Value per ShareCommon

• Records amount of stockholders equity applicable
  to common shares on a per share basis.

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Book Value per SharePreferred

• Records amount of stockholders equity applicable
  to preferred shares on a per share basis.

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Dividend Yield

• Tells us the annual amount of cash dividends
  distributed to common stockholders relative to
  the stocks market price.

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Price Earnings
This ratio reveals information about the stock
markets expectations for a companys future
growth in earnings, dividends, and opportunities.
If earnings go up, will the market price of my
stock follow?
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Homework for Chapter 13

• Ex 13-16, 13-17
• Problem 13-2A, 13-4A
• Due on July 12, 2006 (Wednesday)

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End of Chapter 13