Corporations: Organization, Capital Stock Transactions, and Dividends Instructor’s Lecture P.H.

Characteristics of a Corporation  a legal entity, separate from its owners (stockholders)  limited liability –a stockholder’s loss is limited to his/her investment  subject to double taxation –the corporation pays taxes on earnings –the stockholder pays taxes on dividends received

Organizational Structure of a Corporation Stockholders Board of Directors Officers Employees elect selects hire

Owner’s Equity in a Corporation  is called Stockholders’ Equity, Shareholders’ Equity, Shareholders’ Investment, or Capital  consists of two main sources: 1.paid-in capital (also called contributed capital) 2.retained earnings

Stockholders’ Equity: 1. Paid-in capital is capital contributed to the corporation by the stockholders 2. Retained earnings is net income earned by the corporation and retained (kept) in the business (not distributed to the stockholders in the form of dividends)

Stockholders’ Equity: Paid-in Capital  Paid-in capital is recorded in separate accounts for each class of stock, for example, common stock and preferred stock  If there is only one class of stock, it is called Common Stock, or Capital Stock

Stockholders’ Equity: Retained Earnings  Net income or net loss is closed to the Retained Earnings account at the end of the period  The Dividends account (similar to the Drawing account) is also closed the Retained Earnings account

Stockholders’ Equity: Retained Earnings  Retained earnings is accumulated net income –net income increases retained earnings –dividends decrease retained earnings

Stockholders’ Equity: Retained Earnings  Retained earnings may also be called earnings retained for use in the business, or earnings reinvested in the business  The normal balance of the Retained Earnings account is credit (remember, it is an owners’ equity account)  A debit balance in the Retained Earnings account is called a deficit, and is the result of accumulated net losses

Stockholders’ Equity: Retained Earnings  A deficit is deducted from paid-in capital to determine total stockholders’ equity  Just as net income does not represent cash available, retained earnings does not represent surplus cash

Stockholders’ Equity: Sources of Paid-In Capital  Stock  Donations of real estate or other assets

Stockholders’ Equity: Sources of Paid-In Capital Stock  Authorized –stated in the charter of the corporation  Issued –shares issued (sold) to the stockholders  Outstanding –stock remaining in the hands of the stockholders –shares that receive dividends

Stockholders’ Equity: Sources of Paid-In Capital Classes of Stock  Common Stock –when there is only one class of stock it is “common stock”  Preferred Stock –nonparticipating vs. participating most preferred stock is nonparticipating –cumulative vs. non-cumulative cumulative preferred stock has the right to receive regular dividends that have been passed (are in arrears) before any common stock dividends are paid

Stockholders’ Equity: Sources of Paid-In Capital Preferred Stock  Has preference over common stockholders in receiving dividends  Has preference over common stockholders in receiving assets on liquidation

Stockholders’ Equity: Sources of Paid-In Capital Rights of Stockholders 1. The right to vote 2. The right to share in distributions of earnings (dividends) 3. The right to share in assets on liquidation (the winding up of a corporation when it goes out of business)

Stockholders’ Equity: Sources of Paid-In Capital Terms  Par Value –a monetary amount that may be assigned to a share of stock –related to legal capital (a minimum amount of stockholder contribution that a corporation may be required to retain for the protection of its creditors)  Stated Value –some states may require a corporation to assign a stated value to no-par stock

Stockholders’ Equity: Sources of Paid-In Capital Issuing (Selling) Stock at Par Cash1,500,000 Preferred Stock500,000 Common Stock1,000,000

Stockholders’ Equity: Sources of Paid-In Capital Issuing (Selling) Stock at a Premium Cash110,000 Preferred Stock100,000 Paid-In Capital in Excess of Par-Preferred Stock* 10,000 *When stock is issued at a price that is above par, a separate account is credited for the amount above par

Stockholders’ Equity: Sources of Paid-In Capital Issuing (Selling) Stock With a Stated Value at a Premium Cash400,000 Common Stock250,000 Paid-In Capital in Excess of Stated Value* 150,000 *When no-par stock that has been assigned a stated value is issued at a price that is above par, a separate account is credited for the amount above par

Stockholders’ Equity Treasury Stock  Treasury stock is shares of its own stock that a corporation has once issued and then reacquires  The number of shares issued and the number of shares outstanding will be different if the corporation holds treasury stock  Shares held in the treasury do not receive dividends  Treasury stock reduces total stockholder’s equity

Stockholders’ Equity Reasons for Purchasing Treasury Stock 1. For resale to employees 2. To reissue as a bonus to employees 3. To support (boost) the market price of the stock

Stockholders’ Equity Treasury Stock  Follow the transactions and corresponding journal entries for treasury stock in your text  Use T-accounts to post to the Treasury Stock and Paid-In Capital from Sale of Treasury Stock accounts, and keep track of the number of shares of treasury stock as you do your homework

Stock Splits  A reduction in the par or stated value of a share of common stock, and the issuance of a proportionate number of additional shares  Applies to all shares, including unissued, issued, and treasury shares

Stock Splits  A stock split does not change the total dollar amount of common stock outstanding; only the par value per share and the number of shares is changed  A stock split does not require a journal entry—the details are disclosed in the notes to the financial statements  A stock split does not change the proportional ownership in the corporation for an individual stockholder

Stock Splits Illustrated Assume that a corporation has 10,000 shares of $100 par value common stock outstanding with a market price of $120 per share. The board of directors declares a 4- for-1 stock split. What is the new par value per share, the new total number of shares outstanding, and the the total dollar amount of common stock outstanding after the split?

Stock Splits Illustrated before the splitafter the split par value per share $100$25 ($100/4) # of shares outstanding 10,00040,000 (10,000 shares x 4) total dollar amount of common stock outstanding $1,000,000 ($100/share x 10,000 shares) $1,000,000 ($25/share x 40,000 shares)

Stock Splits Illustrated The proportional ownership in the corporation does not change for an individual stockholder. Let’s say a stockholder has 100 shares before the split: % ownership before the split: % ownership after the split: 100 shares/10,000 shares = 10% 400 shares/ 40,000 shares = 10%

Stock Splits Illustrated What would you expect the market price per share to change to?

Stock Splits Illustrated Did you get $30?* *$120/4

Accounting for Dividends Conditions for a Cash Dividend 1. Sufficient retained earnings  declaration of a dividend reduces retained earnings 2. Sufficient cash 3. Formal action by the board of directors

Accounting for Dividends Important Dates 1. Date of declaration 2. Date of record  determines who gets the dividend 3. Date of payment Journal entries are required for the date of declaration and the date of payment

Accounting for Dividends Cash Dividends Dec. 1Cash Dividends42,500 Cash Dividends Payable42,500 Declared cash dividend Jan. 2Cash Dividends Payable42,500 Cash42,500 Paid cash dividend

Accounting for Dividends Stock Dividends Assume the following information for a corporation: Common Stock, $10 par (200,000 shares issued) On Dec. 15, the board of directors declares a stock dividend of 2% (4,000 shares) to be issued on Jan. 10 to stockholders of record on Dec. 31. The market price of the stock on Dec. 15 is $15 a share.

Accounting for Dividends Stock Dividends Dec. 15Stock Dividends*60,000 Stock Dividends Distributable**40,000 Paid-in Cap. in Excess of Par20,000 Declared stock dividend Jan. 10Stock Dividends Distributable40,000 Common Stock40,000 Issued stock *4,000 shares x $15/share (market price per share on Dec. 15) **4,000 shares x 10 share (par value)

Accounting for Dividends Stock Dividends  A stock dividend does not change the assets, liabilities, or total stockholders’ equity of the corporation. It also does not change the proportional ownership in the corporation for an individual stockholder.

Financial Analysis and Interpretation Dividend Yield Indicates the rate of return to stockholders in terms of cash dividend distributions: Dividends per share of Common Stock Market Price per share of Common Stock Dividend Yield The dividend yield is of special interest to stockholders whose main objective is to receive a current cash return on their investment

Chapter 12: New Accounts AccountCategoryNormal Balance Common StockS/ECredit Preferred StockS/ECredit Paid-in Capital in Excess of Par/Stated ValueS/ECredit Retained EarningsS/ECredit Donated CapitalS/ECredit Treasury StockS/EDebit Paid-in Capital from Sale of Treasury StockS/ECredit Cash Dividends (temporary account)S/EDebit Cash Dividends PayableLiabilityCredit Stock Dividends (temporary account)S/EDebit Stock Dividends DistributableS/ECredit