Corporations: Paid-in Capital and the Balance Sheet Chapter 11

Review the characteristics of a corporation Learning Objective 1 Review the characteristics of a corporation

Advantages and Disadvantages of a Corporation 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

Capital Stock State authorizes how many shares of stock a corporation may issue through corporate bylaws Corporation issues stock certificates when stockholders buy stock Stock held by stockholders is outstanding Copyright (c) 2009 Prentice Hall. All rights reserved

Learning Objective 2 Describe the two sources of stockholders’ equity and the classes of stock

Stockholders’ Equity 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 Paid-in capital Retained earnings

Stockholders’ Rights Four basic rights Vote Dividends Liquidation Preemption that is commonly withheld. (the right to keep the ownership proportion in the corporation) 7

Par and No-par 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 Par value No-par

Classes of Stock Common stock Preferred stock Basic form of capital stock Owners have certain advantages over common Common stock Preferred stock

Learning Objective 3 Journalize the issuance of stock and prepare the stockholders’ equity section of a corporation balance sheet

Accounting for the Issuance of Stock Issue stock at par GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Cash Common stock Copyright (c) 2009 Prentice Hall. All rights reserved

Accounting for the Issuance of Stock Issue stock at a premium GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Cash Common stock Paid-in capital in excess of par Copyright (c) 2009 Prentice Hall. All rights reserved

Issuing Stock Paid-in capital Cash Common stock Amount received Amount over par Par Paid-in capital in excess of par Copyright (c) 2009 Prentice Hall. All rights reserved

Accounting for Stock Issuances 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” Copyright (c) 2009 Prentice Hall. All rights reserved

Accounting for Stock Issuances Issuing stock for noncash assets Issuing preferred stock Copyright (c) 2009 Prentice Hall. All rights reserved

Stockholders’ Equity on the Balance Sheet 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 Copyright (c) 2009 Prentice Hall. All rights reserved

Copyright (c) 2009 Prentice Hall. All rights reserved

Exercise 11-15 Oct 19 Cash (1300 x $12) 15,600 Common stock 1,300 GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT 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 11 Equipment 18,000 6,000 12,000 Copyright (c) 2009 Prentice Hall. All rights reserved

Exercise 11-15 (continued) Total paid-in capital = $14,300 $10,000 $1,300 $6,000 $12,000 $43,600 Copyright (c) 2009 Prentice Hall. All rights reserved

Illustrate Retained earnings transactions Learning Objective 4 Illustrate Retained earnings transactions

Retained Earnings Income Summary Expenses Revenues Net Income GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Income summary Retained earnings Copyright (c) 2009 Prentice Hall. All rights reserved

Deficit Balance If a company incurs a loss, Retained earnings is decreased A debit balance in Retained earnings is called a deficit Copyright (c) 2009 Prentice Hall. All rights reserved

Account for cash dividends Learning Objective 5 Account for cash dividends

Dividend Dates Copyright (c) 2009 Prentice Hall. All rights reserved Declaration date Date of record Payment date Copyright (c) 2009 Prentice Hall. All rights reserved

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 2,000 shares of $100 par 8% preferred = $16,000 dividend 2,000 shares of no-par $3 preferred = $6,000 dividend Copyright (c) 2009 Prentice Hall. All rights reserved

Accounting for Dividends GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Retained earnings Dividends payable Declaration of cash dividend Cash Payment of cash dividend Copyright (c) 2009 Prentice Hall. All rights reserved

Dividing Dividends between Preferred and Common Preferred stockholders receive dividends before common Common stockholders will only receive dividends if total declared is large enough Copyright (c) 2009 Prentice Hall. All rights reserved

Dividend Example A corporation has the following shares outstanding: 10,000 shares of $50 par, 6% preferred stock 50,000 share of $1 par common stock Preferred dividend = 10,000 x $50 x 6% = $30,000 Situation 1: A $50,000 cash dividend is declared Situation 2: A $25,000 cash dividend is declared Preferred receives $30,000 Common receives $20,000 Preferred receives ? Common receives ? Copyright (c) 2009 Prentice Hall. All rights reserved

Cumulative and Noncumulative 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 Copyright (c) 2009 Prentice Hall. All rights reserved

Preferred dividend = 5,000 x $15 x 5% = $3,750 Problem 11-33A Preferred dividend = 5,000 x $15 x 5% = $3,750 a) noncumulative Problem 11-33 shows how cumulative and noncumulative preferred differ. Hip Skincare has 5,000 shares of 5%, $15 par value preferred stock and 80,000 shares of $2.25 par common stock outstanding. During a three-year period, Hip declared and paid cash dividends as follows: 2010, $2,000; 2011, $15,000; and 2012, $20,000. Preferred will receive the first $3,750 of dividends declared. In part (a), the preferred stock is noncumulative. In 2010, only $2,000 of dividends are declared. Preferred receives all of it. Common gets nothing. The preferred shareholders will never receive the unpaid $1,750 from 2010. In 2011, $15,000 is declared. The first $2,000 goes to preferred and the remaining $13,000 goes to common. In 2012, the same pattern follows, except common receives $18,000 Copyright (c) 2009 Prentice Hall. All rights reserved 30

Problem 11-33A (continued) Preferred dividend = 5,000 x $15 x 5% = $3,750 b) cumulative Copyright (c) 2009 Prentice Hall. All rights reserved

Problem 11-33A GENERAL JOURNAL Retained earnings 15,000 DATE DESCRIPTION REF DEBIT CREDIT 2011 12 22 Retained earnings 15,000 Dividends payable – C/S 11,250 Dividends payable – P/S 3,750 2012 1 14 Cash Copyright (c) 2009 Prentice Hall. All rights reserved

Use different stock values in decision making Learning Objective 6 Use different stock values in decision making

Different Values of Stock Market value Price at which a person can buy or sell a share Most important to shareholders Liquidation value Amount guaranteed to preferred if company liquidates Book value Amount of equity per one share of stock Copyright (c) 2009 Prentice Hall. All rights reserved

Book Value per Share 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 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 Copyright (c) 2009 Prentice Hall. All rights reserved

Evaluate return on assets and return on stockholders’ equity Learning Objective 7 Evaluate return on assets and return on stockholders’ equity

Rate of Return on Total Assets Net income + Interest expense Average total assets Copyright (c) 2009 Prentice Hall. All rights reserved

Rate of Return on Common Stockholders’ Equity Net income – preferred dividends Average common stockholders’ equity Copyright (c) 2009 Prentice Hall. All rights reserved

Account for the income tax of a corporation Learning Objective 8 Account for the income tax of a corporation

Income Taxes Income before taxes from the income statement Income tax rate Income tax expense Taxable income from the tax return Income tax rate Income tax payable Copyright (c) 2009 Prentice Hall. All rights reserved

Differences between Income Statement and the Tax Return 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 Copyright (c) 2009 Prentice Hall. All rights reserved

End of Chapter 11