Corporations: Organization, Stock Transactions, and Dividends LO 3a – Understanding the Characteristics and Classes of Stock

Characteristics of Stock LO 3 Characteristics of Stock The number of shares of stock that a corporation is authorized to issue is stated in the charter. The term issued refers to the shares issued to the stockholders. A corporation may reacquire some of the stock that has been issued. The stock remaining in the hands of stockholders is then called outstanding stock. The number of shares of stock a corporation is authorized to issue, or sell, is stated in the charter. Issued shares are sometimes reacquired by the corporation. The stock remaining in the hands of stockholders is then called outstanding stock.

Characteristics of Stock LO 3 Characteristics of Stock Authorized Issued Outstanding Authorized shares are the maximum amount of shares that can be issued by a corporation, as stated in the corporate charter. If a corporation wishes to issue additional shares, it must obtain permission from its state. Issued shares are the number of authorized shares that have been issued or transferred to shareholders. Only issued shares can vote and receive dividends. Outstanding shares are the number of issued shares that are held by the shareholders. Outstanding shares are less than issued shares, when a corporation has reacquired shares from stockholders. Shares that are reacquired from shareholders are called treasury shares. Treasury shares cannot vote or receive dividends.

Characteristics of Stock LO 3 Characteristics of Stock Corporations may issue stock certificates to stockholders to document their ownership. Shares of stock are often assigned a dollar amount, called par value. Some corporations have stopped issuing stock certificates except on special request. A stock’s par value is an arbitrary amount that is assigned to each share of stock. Par value is used to establish the legal capital of the corporation but has no relationship to market value. Market value is the amount that a share of stock is traded at, and its price is a function of demand and other factors. Corporations may issue stock certificates to stockholders to document their ownership.

Characteristics of Stock LO 3 Characteristics of Stock Stock issued without par is called no-par stock. Some states require the board of directors to assign a stated value to no-par stock. Some state laws require that corporations maintain a minimum stockholder contribution, called legal capital, to protect creditors. No-par stock is stock issued without a par value. Some states require the board of directors to assign a stated value to no-par stock when it is issued. Some state laws require that corporations maintain a minimum stockholder contribution, called legal capital. In most states, legal capital includes the amount of par or stated value of the stock issued, multiplied by the number of shares issued.

Characteristics of Stock LO 3 Characteristics of Stock The major rights that accompany ownership of a share of stock are as follows: The right to vote in matters concerning the corporation. The right to share in distributions of earnings. The right to share in assets upon liquidation. The rights of stockholders include: (1) the right to vote, one vote per share of stock held, (2) the right to share in dividends, and (3) the right to share in assets if the corporation is liquidated. Liquidation refers to selling the assets of the corporation and dissolving the corporation.

LO 3 Classes of Stock The two primary classes of paid-in capital are common stock and preferred stock. The primary attractiveness of preferred stock is that it is given a preference to dividends over common stock. The two primary classes of paid-in capital are common stock and preferred stock. Preferred stock gets its name because shareholders have the right to receive dividends and assets in liquidation before common shareholders. Most preferred stock does not carry a right to vote.

LO 3 Classes of Stock Cumulative preferred stock has a right to receive regular dividends that were not declared (paid) in prior years. Noncumulative preferred stock does not have this right. Cumulative preferred stock dividends that have not been paid in prior years are said to be in arrears. Because they have first rights to any dividends, preferred shareholders have a greater chance of receiving dividends than common shareholders. However, since dividends are normally based on earnings, a corporation cannot guaranteed dividends, even to preferred shareholders. Most preferred stock has a cumulative dividend characteristic. If a corporation fails to declare a dividend, the passed dividend accumulates on cumulative preferred stock shares and becomes dividends in arrears. Dividends in arrears accumulate from period to period. A corporation cannot pay common shareholders any dividends until it has paid dividends in arrears.

LO 3 Classes of Stock A corporation has issued the following preferred and common stock: 1,000 shares of $4 cumulative preferred stock, $50 par 4,000 shares of common stock, $15 par The corporation was organized on January 1, 2010, and paid no dividends in 2010 and 2011. In 2012, the corporation paid $22,000 in dividends, of which $12,000 was paid to preferred stockholders and $10,000 was paid to common stockholders. A $22,000 dividend declared in 2012 would be distributed between preferred and common shareholders if the preferred stock is cumulative, and there are two years of dividends in arrears. (continued)

Classes of Stock Total dividends paid $22,000 Preferred stockholders: LO 3 Classes of Stock Total dividends paid $22,000 Preferred stockholders: 2010 dividends in arrears $4,000 The $22,000 dividend declared in 2012 would be distributed in the following manner: --the 2010 dividends are paid first, $4,000. The 2010 dividends in arrears are paid first. There are 1,000 shares, and each share receives $4 for a total of $4,000. (continued)

Classes of Stock Total dividends paid $22,000 Preferred stockholders: LO 3 Classes of Stock Total dividends paid $22,000 Preferred stockholders: 2010 dividends in arrears $4,000 2011 dividends in arrears 4,000 --the 2011 dividends are paid next. The 2011 dividends in arrears are paid next. Again, the preferred stockholders receive $4 for each share held. (continued)

Classes of Stock Total dividends paid $22,000 Preferred stockholders: LO 3 Classes of Stock Total dividends paid $22,000 Preferred stockholders: 2010 dividends in arrears $4,000 2011 dividends in arrears 4,000 2012 dividends 4,000 --the 2012 preferred dividends are paid next. The current dividends for 2012 must be paid to preferred stockholders before common stockholders can participate in the dividends. (continued)

Classes of Stock Total dividends paid $22,000 Preferred stockholders: LO 3 Classes of Stock Total dividends paid $22,000 Preferred stockholders: 2010 dividends in arrears $4,000 2011 dividends in arrears 4,000 2012 dividends 4,000 Total preferred dividends (12,000) A total $12,000 out of the $22,000 of declared dividends are paid to the preferred stockholders first. Of the $22,000 in dividends declared, preferred must receive $12,000 before common can receive any dividends. (continued)

Classes of Stock Total dividends paid $22,000 Preferred stockholders: LO 3 Classes of Stock Total dividends paid $22,000 Preferred stockholders: 2010 dividends in arrears $4,000 2011 dividends in arrears 4,000 2012 dividends 4,000 Total preferred dividends (12,000) Dividends available to common stockholders $10,000 Whatever is left over will then be distributed equally among the common stockholders.