Accounting for Corporations Chapter 13 Accounting for Corporations In this chapter we will learn about various aspects of a corporation. On the income statement, we will learn how to report discontinued operations, extraordinary items, and changes in accounting principles. On the balance sheet, we will learn about accounting issues related to common stock, preferred stock, retained earnings, restrictions, and appropriations. PowerPoint Presentation Modifications by Fred Blake Faculty, San Antonio College

Topics 1. Corporate Form of Organization 2. Common Stock 3. Dividends 4. Stock Splits 5. Preferred Stock 6. Treasury Stock 7. Reporting Equity

Corporate Form of Organization Topic 1 Corporate Form of Organization Page 500

Corporate Form of Organization An entity created by law Ownership can be Privately Held Existence is separate from owners Corporations are entities created by law that exist separately from their owners and that have rights and privileges. Corporations may be privately or publicly owned. Publicly owned corporations have additional reporting responsibilities beyond those of a privately held corporation. Has rights and privileges Publicly Held

Characteristics of Corporations Advantages: Separate legal entity Limited liability of stockholders Continuity of life Transferability of ownership No mutual agency Ease of capital accumulation Disadvantages: Government regulation Corporate taxation

Separate Legal Entity A corporation is an artificial entity that exists apart from its owners. As a separate legal entity, a corporation may own and dispose of property in its own name. The corporation ownership is divided into units called shares of stock. The owners of the shares are called shareholders or stockholders.

Limited Liability A stockholder cannot be held personally responsible for debts of the corporation. Liability is limited to ownership interest in shares of the corporation.

Continuity of Life and Transferability Corporations have continuous life regardless of changes in ownership. Stockholders can dispose of their shares of stock in any manner they desire (sell, trade, gift, etc.). Transfer of stock does not affect the continuity of the corporation.

Mutual Agency Definition: Arrangement whereby all owners act as agents of the business . A contract signed by one owner is binding on the whole business. Does not apply to corporations - a single stockholder cannot commit the corporation to a contract.

Government Regulation State and federal agencies monitor the activities of corporations to protect investor, creditor and the general public. Additional reporting is required, of corporations, by the regulatory agencies (i.e., SEC).

Corporate Taxation The corporation is a separate taxable entity. It is subject to a variety of federal, state and local taxes. After tax earnings (dividends) distributed to stockholders are also taxed again individually. This is called double taxation.

Corporate Form of Organization Corporate Organization and Management Page 501

Forming a Corporation First step is to file an application of incorporation with the state. Because state laws differ, corporations often organize in states with more favorable laws. More than half of the largest companies are incorporated in Delaware. State grants a charter or articles of incorporation which formally create the corporation. Management and board of directors prepare bylaws which are operation rules and procedures.

(owners of corporation stock) Organizational Structure of a Corporation Stockholders (owners of corporation stock) Board of Directors (elected by stockholders) Officers (selected by board of directors) Employees (hired by officers)

Corporate Form of Organization Stockholders

Rights of Stockholders Vote at stockholders’ meetings Sell or dispose of stock Purchase additional shares of stock (Preemptive right ) Receive dividends, if any Share equally in any assets remaining after creditors are paid in a liquidation In addition to voting on important issues at annual meetings, stockholders have the right to buy and sells shares of stock, to receive dividends when declared by the board of directors, and in the event of liquidation, they share equally in any remaining assets after creditors are paid.

Stock Certificates and Transfer Each unit of ownership is called a share of stock. A stock certificate serves as proof that a stockholder has purchased shares. Part I On the right side of your screen is a copy of a stock certificate for AT&T. The share certificate is proof of ownership in AT&T. Part II When stock is sold, the seller signs a transfer endorsement on the back of the stock certificate. When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock certificate.

Corporate Form of Organization Basics of Capital Stock

Basics of Capital Stock Authorized Issued Outstanding Number of Shares

Par Value…... is an arbitrary amount assigned to a share of stock. Only establishes minimum legal capital. Most companies set the par value of their common stock quite low, to avoid legal difficulties from issuing their stock below par.

No-Par Stock…... does not have a par value. Some have a stated value. is an arbitrary value assigned to a share of common stock by the Board of Directors. stated value is similar to par value (once declared by the Board) and treated the same.

Classes of Stockholders The two primary classes of paid-in capital are common stock and preferred stock. The primary attractiveness of preferred stocks is that they are preferred over common as to dividends. Money available for dividends Common Stockholders Preferred Stockholders

Issuing (Selling) Stock Initial Public Offering (IPO) First sale of stock to the public Issuing corporation obtains the assistance of an underwriting firm (investment bank) to determine: (1) Type of security (common or preferred) (2) Best offering price (3) Time to bring securities to market

Selling (Issuing) Stock Issuing (Selling) Stock Par value is an arbitrary amount assigned to each share of stock in the corporate charter. Par value is typically a nominal amount, and is not related in any manner to market value which is the selling price of a share of 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.

Topic 2 Common Stock Page 504

Issuing Stock Par Values Par Value establishes minimum legal capital. Stock Equity accounts are credited only for the par value of each share of stock issued. - Common Stock - Preferred Stock Stock par values are usually set forth in the Articles of Incorporation.

Issuing Par Value Stock Stock Issued at Par Value On June 5, Dillon, Inc. issued 30,000 shares of $10 par value stock for $300,000. Record: The cash received. The number of shares issued × the par value per share in the Common Stock account.

Issuing Par Value Stock Stock Issued at Par Value On June 5, Dillon, Inc. issued 30,000 shares of $10 par value stock for $300,000. Jun 5 Cash 300 000.00 Common Stock, $10 Par Value 300 000 00 Issued 30,000 shares of $10 par value common stock.

Issuing Par Value Stock Stock Issued at a Premium On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Record: The cash received. The number of shares issued × the par value per share in the Common Stock account. The remainder is assigned to Paid-In Capital in Excess of Par Value, Common Stock. When par value stock is sold for cash, the Common Stock account is credited for the par value of the stock sold. Remember that par value and market value are not related. The difference between the par value of the stock and the market value of the stock is credited to Contributed Capital in Excess of Par. If you added together the amount of par value in the Common Stock account and the amount in the Paid-In Capital in Excess of Par, Common Stock, you would have the market value of the sale of the stock.

Issuing Par Value Stock Stock Issued at a Premium On September 1, Matrix, Inc. issued 100,000 shares of $2 par value stock for $25 per share. Sep 1 Cash (100,000 x $25) 2,500, 000 00 Common Stock (100,000 x $2) 200 000 00 Paid-in Capital in Excess of Par-- Common Stock 2,300 000 00 Issued 100,000 shares of common stock at $25 per share.

Issuing Par Value Stock This is the way Matrix would report the common stock on its balance sheet. The two hundred thousand dollars is the par value of the stock sold and the two million, three hundred thousand dollars is the excess over par value Matrix received for the stock. These two amounts added together total two million, five hundred thousand dollars, the amount of cash received for the sale of the stock.

Issuing No-Par Stock Par Values No-Par Stock is stock that is issued without a par value. Stock Equity accounts are credited for the full amount received for each share of stock issued.

Issuing No-Par Stock On October 20, a corporation issues 1,000 shares of no-par common stock for $40 per share. Oct 23 Cash 40 000 00 Common Stock, No-Par Value 40 000 00 Issued 1,000 shares of no-par common stock at $40.

Issuing No-Par Stock No-par stock may be assigned a stated value per share. In this case the stated value is recorded similar to a par value.

Issuing No-Par Stock No-Par Stock, Stated Value per share. Stock Equity accounts are credited for the stated par value and the excess is credited to the appropriate paid-in capital in excess of par account. Accounting is essentially the same as for regular par value stock.

Issuing Stock with a Stated Value On June 17, issued an additional 1,000 shares of no-par common stock at $36; stated value, $25. Jun 17 Cash (1,000 x $36) 36 000 00 Common Stock (1,000 x $25) 25 000 00 Paid-in Capital in Excess of Stated Value-Common Stock 11 000 00 Issued 1,000 shares of no-par common stock at $36; stated value, $25.

Issuing Stock for Non-Cash Assets Stock issued for assets other than cash should be recorded at the fair market value of the asset.

Issuing Stock for Non-Cash Assets On Nov. 12, a corporation acquired land for which the fair market value is $120,000. The corporation issued 10,000 shares of $10 par common in exchange for the land. Nov. 12 Land (10,000 x $12) 120 000 00 Common Stock (10,000 x $10) 100 000 00 Paid-in Capital in Excess of Par-Com. Stk 20 000 00 Issued 10,000 shares of $10 par common stock for land.

Topic 3 Dividends Page 507

Dividends Cash Dividends

Cash Dividends Regular cash dividends provide a return to investors and almost always affect the stock’s market value. Corporation June 30 Stockholders receive a return on their investment in two ways: one is through increases in the market value of the stock and one is through cash dividends. Stockholders Dividends

Cash Dividends Dividends are distributions of retained earnings to stockholders. Dividends are never required, but once declared become a legal liability of the corporation.

2. Sufficient cash Accounting for Cash Dividends Retained Earnings Corporations generally declare and pay cash dividends on shares outstanding when three conditions exist: 1. Sufficient retained earnings 2. Sufficient cash 3. Formal action by the board of directors Retained Earnings 50,000

Accounting for Cash Dividends There are three important dates relating the dividends.

Accounting for Cash Dividends Cash Dividend Dates Date of Declaration (formal action by the Board). Date of Record (establishes ownership of dividends). Date of Payment (dividend checks are issued).

Accounting for Cash Dividends Three important dates Dividends There are three important dates to remember when discussing dividends:  The date of declaration is the date the directors declare the dividend. At this time, a liability is created and must be recorded.  The date of record is important because you must own the stock on this date to receive the dividend. No entry is required in the accounting records.  The date of payment is the date the corporation pays the dividend to the stockholders who owned the stock on the record date. Let’s look at an example. Date of Declaration Date of Record Date of Payment Record liability for dividend. No entry required. Record payment of cash to stockholders.

Accounting for Cash Dividends Date of Declaration Assume that on January 9, Z-Tech, Inc. declares a $1 per share dividend, with 5,000 outstanding shares. The dividend will be paid on February 1 to stockholders of record on January 22. Jan 9 Retained Earnings ($1 x 5,000) 5 000 00 Common Dividends Payable 5 000 00 Declared cash dividend.

Accounting for Cash Dividends Date of Record The second important date is the date of record. For Z-Tech, Inc. this would be January 22.

Accounting for Cash Dividends Date of Record This date establishes ownership of the shares and determines who receives the dividend. No entry is required.

Accounting for Cash Dividends Date of Payment On February 1, Z-Tech, Inc. issues dividend checks. Jan. 2 Cash Dividends Payable 5 000 00 Cash 5 000 00 Paid cash dividends.

Dividends Stock Dividends

Accounting for Stock Dividends A distribution of dividends to stockholders in the form of the firm’s own shares is called a stock dividend. Why a stock dividend? Can be used to keep the market price on the stock affordable. Can provide evidence of management’s confidence that the company is doing well.

Accounting for Stock Dividends are a proportional distribution of a corporation’s own stock to its shareholders. they do not change total stockholders’ equity. nor do they transfer assets of the corporation to the stockholders.

Accounting for Stock Dividends Stock Dividend Dates Date of Declaration (formal action by the Board). Date of Record (establishes ownership of dividends). (No journal entry) Date of Distribution (stock shares are issued).

Accounting for 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 > 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.

Accounting for Stock Dividends Small Stock Dividend Dividend < 25% of the outstanding shares

Recording a Small Stock Dividend On December 31, 2008, Quest declared a 2% stock dividend, when the stock was selling for $10 per share. The stock will be distributed on January 20, 2009, to stockholders of record as of January 15. Dec. 31 Retained Earnings 20 000 00 Stock Dividends Distributable 2 000 00 Paid-in Capital in Excess of Par—Common Stock 18 000 00 Declared 2% stock dividend. Retained Earnings - (100,000 shares × 2% = 2,000 shares × $10 = $20,000) Stock Dividends Distributable - ( 2,000 shares × $1 par = $2,000)

Before the stock dividend. After the stock dividend. Comparing Quest’s equity section before and after the stock dividend shows that the Common Stock dividend Distributable account is reported with the common stock and the Contributed Capital in Excess of Par Value is reported as additional paid in capital. Retained Earnings also decreased based on the previous entry. After the stock dividend.

Recording a Small Stock Dividend Date of Record January 15 On this date, ownership of shares determines who receives the stock dividend. No entry is required. Here is the equity section for Quest Incorporated prior to a small stock dividend.

Recording a Small Stock Dividend Date of Distribution On January 20, Quest issues the stock. This action increases the number of shares outstanding by 2,000. Jan. 20 Stock Dividends Distributable 2, 000 00 Common Stock 2, 000 00 Issued stocks for the stock dividend.

Accounting for Stock Dividends Large Stock Dividend Dividend > 25% of the outstanding shares

Recording a Large Stock Dividend On December 31, 2008, 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. Dec. 31 Retained Earnings 20 000 00 Stock Dividends Distributable 20 000 00 Declared 20,000 share (40%) stock dividend. 50,000 × 40% = 20,000 shares × $1 par value = $20,000

Recording a Large Stock Dividend Effects on the balance sheet accounts are similar to a small stock dividend, except the paid-in capital in excess of par is not changed. Router Corporation, December 31, 2008 (before dividend) Common Stock, $1 par, 200,000 Auth, 50,000 Outstanding $50,000 Paid-in Capital in Excess of Par--Common Stock 75,000 Retained Earnings 100,000 Total Stockholders’ Equity $225,000 Router Corporation, December 31, 2008 (after dividend) Common Stock, $1 par, 200,000 Auth, 50,000 Outstanding $50,000 Common Stock Dividend Distributable, 20,000 Shares 20,000 Paid-in Capital in Excess of Par--Common Stock 75,000 Retained Earnings 80,000 Total Stockholders’ Equity $225,000

Topic 4 Stock Splits Page 510

Stock Splits A corporation sometimes reduces the par or stated value of their common stock and issues a proportionate number of additional shares. This is called a stock split.

Accounting for Stock Splits An example: A corporation has 100,000 shares of $20 par common stock outstanding, when a 2-for-1 stock split is declared by the Board of Directors. Before: 100,000 shares @ $20 par = $2,000,000 After: 200,000 shares @ $10 par = $2,000,000 The total legal capital is the same. Only the number of shares and the par per share are changed. No journal entry is required.

Accounting for Stock Splits Individual Shareholder BEFORE STOCK SPLIT 8 shares, $10 par AFTER 2-1 STOCK SPLIT 4 shares, $20 par $80 total par value $80 total par value

Accounting for Stock Splits A stock split does not change the balance of any corporation account. However, it can make the stock more attractive to investors by reducing the price of a share.

Topic 5 Preferred Stock Page 510

Usually has a stated dividend rate Normally has no voting rights 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

Most preferred stock is nonparticipating. Vs. Non-Participating Participating Dividends may exceed a stated amount once common stockholders receive a dividend equal to the preferred stated rate. Dividends are limited to a maximum amount each year. The maximum is usually the stated dividend rate. Most preferred stock is nonparticipating.

Non-Participating Preferred Stock Are classified in two categories: 1 - Non-Cumulative Preferred Stock 2 - Cumulative Preferred Stock Dividend rights of preferred stock are usually stated in specific monetary terms or as a percentage of par value.

Issuing Preferred Stock On July 1, Dillon, Inc. issues 50 shares, $100 par value, for $120 per share. Sep 1 Cash (50 x $120) 6, 000 00 Preferred Stock (50 x $100) 5 000 00 Paid-in Capital in Excess of Par-- Preferred Stock 1 000 00 Issued 50 shares of Preferred stock at $120 per share.

Non-Cumulative Preferred Stock A non-participating (non-cumulative) preferred stock is limited to a certain amount. Assume 1,000 shares of 4% non-participating, $100 par, preferred stock and 4,000 shares of common stock and the following: 2007 2008 2009 Net income $20,000 $55,000 $62,000 Amount retained (10,000) (20,000) (40,000) Amount distributed $10,000 $35,000 $22,000 Preferred dividend (4,000) (4,000) (4,000) Common dividend $ 6,000 $31,000 $18,000 Dividends per share: Preferred $ 4.00 $ 4.00 $ 4.00 Common $ 1.50 $ 7.75 $ 4.50

Cumulative Preferred Stock Cumulative preferred stock are entitled to receive regular dividends each fiscal period, whether declared or not. Dividends, not declared for a period, accumulate until paid and are said to be in arrears. Preferred dividends in arrears and current preferences are paid first before any dividends are paid to common stockholders.

Cumulative Preferred Stock So, preferred dividends are two years in arrears. Assume 1,000 shares of $4 cumulative, $100 par, preferred stock and 4,000 shares of common stock. No dividends were paid in 2006 and 2007.

Cumulative Preferred Stock On November 7, 2008, the board of directors declares dividends of $22,000.

Cumulative Preferred Stock Preferred Stock Dividends Dividends Paid in 2008 Total dividends paid, $22,000 $4,000 2006 (In arrears) $4,000 $10,000 $4,000 2007 (In arrears) $4,000 $4,000 2008 (Current dividend) $4,000 Preferred Stock Common Stock

Reasons for Issuing Preferred Stock To raise capital without sacrificing control. To boost the return earned by common stockholders through financial leverage. To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low.

Other Preferred Stock Options Convertible Preferred Stock – Gives the holders the option to exchange their preferred shares for common shares at a specific rate (i.e., 1:10). Callable Preferred Stock (1) Gives the issuing corporation the right to retire this stock from its holders at specified future dates and prices. (2) The call price usually includes the stock par value plus a premium.

Topic 6 Treasury Stock Page 514

Treasury Stock Transactions Occasionally, a corporation buys back its own stock for the purpose of later reissuing it. This stock is referred to as treasury stock.

Primary Uses of Treasury Stock Employee stock purchase plans. Employee/Officer bonus plans. Influence stock market price. Acquire another corporation. To avoid hostile takeover of the company.

Treasury Stock Transactions Treasury stock is stock that: 1. has been issued as fully paid. 2. has been reacquired by the corporation. 3. has not been canceled or reissued.

Treasury Stock Transactions 1. A commonly used method of accounting for treasury stock is the cost method. 2. The account Treasury Stock is debited for the cost of a purchase. 3. When sold, Treasury Stock is credited for its’ original cost and any difference is debited or credited to an account titled Paid-In Capital, Treasury Stock.

Treasury Stock Transactions Acquiring treasury shares does not decrease the number of shares issued. Total equity decreases, as does the number of shares outstanding. Losses, on sales of treasury shares, are debited to Paid-in Capital, Treasury Stock, to the extent there is a balance in that account. Losses, that exceed the balance of the Paid-in Capital, Treasury Stock account, are debited to Retained Earnings.

Treasury Stock Transactions Cost Method On January 5, a firm purchased 1,000 shares of treasury stock (common stock, $25 par) at $45 per share. Jan. 5 Treasury Stock, Common 45 000 00 Cash 45 000 00 Purchased 1,000 shares of treasury stock at $45.

Treasury Stock Transactions Cost Method On June 2, sold 200 shares of treasury stock at $60 per share. June 2 Cash (200 x $60) 12 000 00 Treasury Stock, Common (200 x $45) 9 000 00 Paid-in Capital, Treasury Stock 3 000 00 Sold 200 shares of treasury stock at $60.

Treasury Stock Transactions Cost Method On September 3, sold 200 shares of treasury stock at $40 per share. Sep. 3 Cash (200 x $40) 8 000 00 Paid-in Capital, Treasury Stock 1 000 00 Treasury Stock, Common (200 x $45) 9 000 00 Sold 200 shares of treasury stock at $40.

Treasury Stock Transactions Paid-in capital: Common stock, $25 par (20,000 shares authorized and issued, 19,400 outstanding).. $500,000 Excess of issue price over par…………………. 150,000 From sale of treasury stock…………………….. 2,000 Total paid-in capital……………………….. $652,000 Retained earnings…………………………………. 130,000 Total………………………………………………. $782,000 Deduct treasury stock (600 shares at cost)…... (27,000) Total stockholders’ equity……………………….. $755,000 Debit balance of Treasury Stock account.

Treasury Stock Transactions Cost Method On October 4, sold 400 shares of treasury stock at $39 per share. Loss exceeds balance in Paid-In Capital From Sale of Treasury Stock Account. Sep. 3 Cash (200 x $39) 15 600 00 Paid-In Capital, Treasury Stock 2 000 00 Retained Earnings 400 00 Treasury Stock, Common (400 x $45) 18 000 00 Sold 200 shares of treasury stock at $39.

Topic 7 Reporting Equity Page 516

Reporting Stockholders’ Equity Total cumulative amount of reported net income, less any net losses and dividends declared, since the company started operating. The Statement of Retained Earnings is a summary of the activity that occurred in Retained Earnings during the period. It begins with the balance at the beginning of the period. If a company has net income, it is added to the beginning retained earnings balance. If a company has a net loss, then that would be subtracted. Any dividends declared are subtracted to arrive at the ending Retained Earnings balance.

Reporting Stockholders’ Equity Many companies issue a Statement of Stockholders’ Equity rather than a simple Statement of Retained Earnings. The Statement of Stockholders’ Equity is more inclusive and discloses changes in all equity accounts, not just Retained Earnings. This is a more inclusive statement than the statement of retained earnings.

Reporting Stockholders’ Equity Restricted/Appropriated Retained Earnings Retained earnings may be limited (restricted) by action of the corporations’ board of directors. Retained earnings may also be appropriated for purposes such as business expansions. Other restrictions may be result of legal and contractual requirements. These items remain a part of retained earnings, however they are usually disclosed by notes to the financial statements.

Restricted Retained Earnings restrictions on paying 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. Retained earnings can have legal or contractual restrictions. In most states, the corporate charters will not allow companies to purchase treasury stock in excess of the balance in retained earnings. Some loan agreements place restrictions on how much dividends can be based on the balance in retained earnings. Restrictions on retained earnings are generally disclosed in the notes to the financial statements.

Appropriated Retained Earnings A corporation’s directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities. Directors can voluntarily limit the use of retained earnings. This is called an appropriation. When there is an appropriation of retained earnings, it is separately reported in the financial statements and disclosed to inform users of special activities that require funds.

Reporting Stockholders’ Equity Prior Period Adjustments Material errors, from previous periods, are not included in the computation of current period net income. Such adjustments are reflected as adjustments to the Retained Earnings beginning balance, in the period they are identified. Adjustments are reported in the Statement of Retained Earnings.

Reporting Stockholders’ Equity Reed, Inc. Statement of Retained Earnings For the Year Ended December 31, 2008 Retained earnings, January 1, 2008………………… $ 350,000 Prior Period Adjustment: Cost of land incorrectly charged to expense………………………………… 30,000 Retained earnings, January 1, 2008, as adjusted….. $380,000 Net income……………………………………………. $ 280,000 Less dividends declared……………………………… (75,000) Increase in retained earnings………………………... 205,000 Retained earnings, December 31, 2008……………… $ 585,000

End of Chapter 13 In this chapter we learned about various aspects of a corporation. We learned about accounting issues related to common stock and different types of preferred stock. We also learned about the statement of retained earnings and how to account for restrictions and appropriations.