Chapter 11

Identify the distinguishing characteristics of a corporation

Copyright © 2009 Prentice Hall. All rights reserved ADVANTAGESDISADVANTAGES  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 3

 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 4Copyright (c) 2009 Prentice Hall. All rights reserved

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

Copyright © 2009 Prentice Hall. All rights reserved Paid-in capitalRetained 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 6

Copyright © 2009 Prentice Hall. All rights reserved Stockholders’ Equity Before Stock is Issued Stockholders’ Equity Paid-in capital: Common stock $ 0 Retained earnings 0 Total stockholders’ equity $ 0 7

Copyright © 2009 Prentice Hall. All rights reserved Common stockPreferred 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 8

Copyright © 2009 Prentice Hall. All rights reserved Par valueNo-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 9

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

11 Issue stock at par GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Cash Common stock Copyright (c) 2009 Prentice Hall. All rights reserved

12 Issue stock at a premium GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Cash Common stock Paid-in capital in excess of par Copyright (c) 2009 Prentice Hall. All rights reserved

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

 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” 14Copyright (c) 2009 Prentice Hall. All rights reserved

 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 15Copyright (c) 2009 Prentice Hall. All rights reserved

 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 16Copyright (c) 2009 Prentice Hall. All rights reserved

17Copyright (c) 2009 Prentice Hall. All rights reserved

GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Oct19Cash (1300 x $12)15,600 Common stock1,300 Paid-in capital in excess of par-C/S14,300 Nov3Cash10,000 Preferred stock10,000 Nov11Equipment18,000 Common stock6,000 Paid-in capital in excess of par-C/S12, Copyright (c) 2009 Prentice Hall. All rights reserved

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

Illustrate Retained earnings transactions

GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Income summary Retained earnings 21 Income Summary RevenuesExpenses 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 22Copyright (c) 2009 Prentice Hall. All rights reserved

Account for cash dividends

Declaration date Date of recordPayment date 24Copyright (c) 2009 Prentice Hall. All rights reserved

 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 25 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

26 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Retained earnings Dividends payable Declaration of cash dividend Dividends payable Cash Payment of cash dividend Copyright (c) 2009 Prentice Hall. All rights reserved

 Preferred stockholders receive dividends before common  Common stockholders will only receive dividends if total declared is large enough 27Copyright (c) 2009 Prentice Hall. All rights reserved

28 A corporation has the following shares outstanding: 10,000 shares of $50 par, 6% preferred stock 50,000 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 receives $30,000 Common receives $20,000 Preferred receives $25,000 Situation 2: A $25,000 cash dividend is declared Common receives nothing Copyright (c) 2009 Prentice Hall. All rights reserved

 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 29Copyright (c) 2009 Prentice Hall. All rights reserved

30 Preferred dividend = 5,000 x $15 x 5% = $3,750 YearPreferredCommon 2010$2, Preferred dividend$3,750 Remainder$11, Preferred dividend$3,750 Remainder$16,250 a) noncumulative Copyright (c) 2009 Prentice Hall. All rights reserved

31 Preferred dividend = 5,000 x $15 x 5% = $3,750 YearPreferredCommon 2010$2, In arrears$1,750 Current year$3,750 $5,500 Remainder$9, Current year$3,750 Remainder$16,250 b) cumulative Copyright (c) 2009 Prentice Hall. All rights reserved

32 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Retained earnings15,000 Dividends payable – C/S11,250 Dividends payable – P/S3, Dividends payable – C/S11,250 Dividends payable – P/S3,750 Cash15,000 Copyright (c) 2009 Prentice Hall. All rights reserved

Use different stock values in decision making

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 34Copyright (c) 2009 Prentice Hall. All rights reserved

Book value of preferred stock: Liquidation price or Preferred stock accountA Dividends in arrears on any outstanding preferred sharesB Total book value attributed to preferred stockA+B Number of outstanding preferred sharesC Book value per share of preferred stock(A+B)/C 35 Book value of common stock: Total stockholders’ equityD Less: book value attributed to preferredA+B Total book value attributed to common stockD-(A+B) Number of outstanding common sharesE Book value per share of common stockD-(A+B)/E Copyright (c) 2009 Prentice Hall. All rights reserved

Evaluate return on assets and return on stockholders’ equity

37 Net income + Interest expense Average total assets Copyright (c) 2009 Prentice Hall. All rights reserved

38 Net income – Preferred dividends Average common stockholders’ equity Copyright (c) 2009 Prentice Hall. All rights reserved

Account for the income tax of a corporation

40 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 Copyright (c) 2009 Prentice Hall. All rights reserved

 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 41Copyright (c) 2009 Prentice Hall. All rights reserved