Chapter 11. Identify the distinguishing characteristics of a corporation

Chapter 11

Identify the distinguishing characteristics of a corporation

Copyright © 2009 Prentice Hall. All rights reserved

ADVANTAGES DISADVANTAGES

Ability to raise money

Continuous life Easy to transfer

ownership No mutual agency Limited liability

Separation of ownership and management

Double taxation Expensive

government regulation

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State authorizes how many shares of stock a corporation may issue through corporate bylaws

Corporation issues stock certificates when stockholders buy stock◦ Basic unit of stock is a share

Stock held by stockholders is outstanding

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Describe the two sources of stockholders’ equity and the classes of stock


Paid-in capital Retained earnings

Amounts received from stockholders

Common stock is main source

Externally generated Resulting from

transactions with outsiders

Earned by profitable operations

Internally generated Results from internal

corporate decisions and earnings

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Stockholders’ Equity

Paid-in capital:

Common stock $ 0

Retained earnings 0

Total stockholders’ equity $ 0

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Common stock Preferred stock

Basic form of capital stock

Owners have certain advantages over common◦ Receive dividends before

common◦ Upon liquidation, receive

assets before common◦ Right to vote sometimes

withheld

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Par value No-par

Arbitrary amount assigned by company to a share of stock

Usually set low as to avoid legal difficulties

No arbitrary amount assigned by company to a share of stock

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Journalize the issuance of stock and prepare the stockholders’ equity section of a

corporation balance sheet

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Issue stock at parGENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Cash

Common stock

Copyright (c) 2009 Prentice Hall. All rights reserved

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Issue stock at a premiumGENERAL JOURNAL


Cash

Common stock

Paid-in capital in excess of par


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Paid-in capital

Common stock

Par

Paid-in capital in excess of par

Amount received over par

Cash

Amountreceived


No-par stock◦ No “Paid-in capital in excess of par” account

needed◦ Full amount received is credited to “Common

stock” account Stated value stock

◦ Similar to accounting for par value stock◦ Amount above stated value is credited to “Paid-in

capital in excess of stated value”


Issuing stock for noncash assets◦ Asset is debited for its fair value

Issuing preferred stock◦ Similar to issuing common stock, except

“Preferred stock” is credited at par value◦ Preferred stock usually is not issued above par


Equity accounts are listed in the following order on the balance sheet◦ Preferred stock◦ Paid-in capital in excess of par – preferred◦ Common stock◦ Paid-in capital in excess of par – common◦ Retained earnings


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Stockholders' Equity

Preferred stock, 6%, $50 par, 2000 shares authorized and issued 100,000$

Paid-in capital in excess of par - preferred 5,000

Common stock, $1 par, 1,000,000 shares authorized, 500,000 issued 500,000

Paid-in capital in excess of par - common 750,000

Total paid-in captial 1,355,000

Retained earnings 715,000 Total stockholders' equity 2,070,000$

Any CompanyBalance Sheet

December 30, 2010


GENERAL JOURNAL


Oct 19 Cash (1300 x $12) 15,600

Common stock 1,300

Paid-in capital in excess of par-C/S

14,300

Nov

3 Cash 10,000

Preferred stock 10,000

Nov

11 Equipment 18,000

Common stock 6,000

Paid-in capital in excess of par-C/S

12,00018


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Total paid-in capital =

$12,000$12,000

$1,300$1,300

$6,000$6,000

$14,300$14,300 $10,000$10,000

$43,600


Illustrate Retained earnings transactions

GENERAL JOURNAL


Income summary

Retained earnings

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Income SummaryRevenuesExpenses

Net Income

Closing entry #1

Closing entry #2

Closing entry #3

If a company incurs a loss, Retained earnings is decreased

A debit balance in Retained earnings is called a deficit


Account for cash dividends


Preferred dividends expressed as either:◦ A percent of par value

◦ Or a flat dollar amount per share

Common dividends expressed as a dollar amount per share

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2,000 shares of $100 par 8% preferred = $16,000

dividend

2,000 shares of no-par $3 preferred = $6,000

dividend


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GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

Retained earnings

Dividends payable

Declaration of cash dividend

Dividends payable

Cash

Payment of cash dividend


Preferred stockholders receive dividends before common

Common stockholders will only receive dividends if total declared is large enough


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A corporation has the following shares outstanding:

10,000 shares of $50 par, 6% preferred stock50,000 share of $1 par common stock

Situation 1: A $50,000 cash dividend is declared

Preferred dividend = 10,000 x $50 x 6% = $30,000

Preferred dividend = 10,000 x $50 x 6% = $30,000

Preferred receives $30,000

Common receives $20,000

Preferred receives $25,000

Situation 2: A $25,000 cash dividend is declared

Common receives nothing


Cumulative preferred stock ◦ Accumulates dividends each year until the

dividends are paid◦ Dividends in arrears - dividends passed or not

paid Noncumulative preferred stock

◦ Dividends not paid do not accumulated from one year to the next


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Preferred dividend = 5,000 x $15 x 5% = $3,750Preferred dividend = 5,000 x $15 x 5% = $3,750

Year Preferred

Common

2010 $2,000 0

2011 Preferred dividend

$3,750

Remainder $11,250

2012 Preferred dividend

$3,750

Remainder $16,250

a) noncumulative


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Preferred dividend = 5,000 x $15 x 5% = $3,750Preferred dividend = 5,000 x $15 x 5% = $3,750

Year Preferred

Common

2010 $2,000 0

2011 In arrears $1,750

Current year $3,750

$5,500

Remainder $9,500

2012 Current year $3,750

Remainder $16,250

b) cumulative


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GENERAL JOURNALDATE DESCRIPTION REF DEBIT CREDIT

2011

12 22

Retained earnings 15,000

Dividends payable – C/S

11,250

Dividends payable – P/S 3,7502012

1 14

Dividends payable – C/S 11,250

Dividends payable – P/S 3,750

Cash 15,000Copyright (c) 2009 Prentice Hall. All

rights reserved

Use different stock values in decision making


Book value of preferred stock:

Liquidation price or Preferred stock account A

Dividends in arrears on any outstanding preferred shares B

Total book value attributed to preferred stock A+B

Number of outstanding preferred shares C

Book value per share of preferred stock (A+B)/C

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Book value of common stock:

Total stockholders’ equity D

Less: book value attributed to preferred A+B

Total book value attributed to common stock D-(A+B)

Number of outstanding common shares E

Book value per share of common stock D-(A+B)/E


Evaluate return on assets and return on stockholders’ equity

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Net income + Interest expense

Net income + Interest expense

Average total assetsAverage total assets


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Net income – Preferred dividendsNet income – Preferred dividendsAverage common stockholders’

equityAverage common stockholders’

equity


Account for the income tax of a corporation

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Income tax expense

Income before taxes

from the income

statement

Income tax rate

Income tax payable

Taxable income from

the tax return

Income tax rate


Income statement◦ Financial statement showing revenues and

expenses Tax return

◦ Reports to Internal Revenue Service Accounting rules and tax rules can differ

◦ Example: Depreciation expense Income statement: straight-line Tax return: accelerated method used to reduce

taxable income and save tax dollars◦ Normal first year result: a deferred tax liability


Documents

Chapter 11. Identify the distinguishing characteristics of a corporation