©CourseCollege.com 1 23 Corporations Learning Objectives 1.Identify characteristics of a corporation 2.Account for organizing a corporation 3.Account for cash dividends 4.Describe the structure of bonds, their issuance and interest payments 5.Analysis: Compute and explain return on common stockholder’s equity A review of the Equity section of the balance sheet will indicate the corporate form of business organization

©CourseCollege.com 2 Corporations Some of the disadvantages and advantages to the corporate form Disadvantages double taxation the cost to organize and maintain Advantages Limited liability of owners Unlimited life of corporations Ease of transfer of equity and capital formation

©CourseCollege.com 3 Objective 23.1: Identify characteristics of a corporation O23.1 A corporation is an entity created by law at a state level. It has a separate identity from its owners and has most of the rights and privileges of individuals. Accounting for corporations differs from proprietorships and partnerships in the way the equity section is organized.

©CourseCollege.com 4 Corporate organization Stockholders (Owners) ELECT Board of Directors (Directors) APPOINT Corporate Officers (Managers) MANAGE Employees O23.1

©CourseCollege.com 5 Corporate classification Public corporations are owned by or related to governmental units (i.e. Tennessee Valley Authority, Port of Seattle). Private corporations are privately owned either (non stock) or not- for-profit organizations or for profit stock issuing organizations (i.e. Ford, Exxon, GE). Who Owns the Corporation? O23.1

©CourseCollege.com 6 Corporate classification Open & owned by the public with stock available for purchase generally listed for sale by one of the national or regional stock exchanges. Often called publicly traded corporations. Closed, ownership held by a few stockholders with stock not available for purchase by the general public. Who Can become an Owner? O23.1

©CourseCollege.com 7 Corporate classification Domestic when operating in the state where the corporation was originally incorporated. Foreign when legally operating in states other than the state in which it was incorporated. Where is the Corporation from? O23.1

©CourseCollege.com 8 Corporate overview O23.1 Limited Liability  Owners and managers are not liable for corporate debt  Creditors can seek and obtain owner and manager liability by separate agreement

©CourseCollege.com 9 Corporate overview O23.1 Restricted Agency  Owners cannot act as agents for the corporation  Only authorized corporate officers and employees can act to bind the corporation  Major corporate decisions may require board of directors approval

©CourseCollege.com 10 Corporate overview O23.1 Unlimited Life Corporations are legal entities with potential unlimited life Maintenance of state level reporting and registering requirements is necessary to maintain corporation

©CourseCollege.com 11 Corporate overview O23.1 Income tax  Corporations are taxable entities  Corporations pay income taxes based on graduated scales

©CourseCollege.com 12 Stock Ownership Common stockholders have the following rights:  To vote at stockholders’ meeting. In particular to elect members of the board of directors  To sell or transfer their stock ownership to others  To share in earnings  To purchase additional shares if more shares are issued by the corporation.  After creditors have been paid, to share in the assets of the corporation if it is liquidated O23.1

©CourseCollege.com 13 Corporate shares of stock O23.1 Authorized Shares Issued Shares Outstanding Shares Outstanding Shares Corporate charters indicate the number of shares of stock that the corporation is authorized to sell. If any of the authorized stock is sold, it is referred to as issued. While issued stock is still in circulation it is referred to as outstanding. Stock can be issued and not outstanding* if the corporation repurchases the shares of stock and holds them as treasury stock. Repurchased shares may also be retired

©CourseCollege.com 14 Corporate Equity -comparison Proprietorship Partnership Corporation O23.1

©CourseCollege.com 15 Preferred & common shares of stock O23.1 Corporations may issue: Common shares -the basic type of stock Preferred shares -with special rights and privileges More than one class of both common and preferred stock

©CourseCollege.com 16 Preferred stock O23.1 Typically is offered without the right to vote. This arrangement evolved to allow corporations raise capital without diminishing the control structure held by existing common stockholders Normally has a stated dividend rate Preferred stockholders receive a preference for any cash dividends Preferred stockholders receive a preference over common stockholders in the event of liquidation (not over creditors)

©CourseCollege.com 17 Preferred cash dividend preference O23.1 Common Stockholders Preferred Stockholders Cash Dividends Paid Here I‘m sorry, you’ll have to wait here until the preferred stockholders get paid.

©CourseCollege.com 18 Par value stock When incorporating, par value stock may be issued Par value is a dollar amount of value assigned arbitrarily to each share of stock. This par value has no effect on what price the stock will sell for now or in the future Most states also now permit no par value stock to be issued No par value stock sometimes is assigned a value after the initial stock sale, it is referred to as stated value stock O23.1

©CourseCollege.com 19 Minimum legal capital States typically require corporations to establish and to some extent, maintain what is called minimum legal capital This is the total dollar amount of equity that must be raised per the charter authorization. Unless it is in liquidation, the corporation is required in most states to maintain this minimum legal capital for the protection of creditors The corporation may not distribute assets to stockholders if the result would be to lower the equity level below the minimum legal capital required Usually the par value times the minimum number of shares required to be sold initially under the charter becomes the minimum legal capital. In the case of no par value stock, the entire proceeds from the initial sale of stock becomes the minimum legal capital O23.1

©CourseCollege.com 20 Sale of par value stock O23.1 Corporation When par value stock is sold, the market price per share rarely, if ever, equals the par value. The equity accounts established in the corporate equity section must maintain the par values. Therefore, two separate accounts are used: 1)Common Stock at Par and 2)Contributed Capital in Excess of Par. Together, these two accounts are commonly referred to as paid-in or contributed capital.

©CourseCollege.com 21 Contributed capital & Retained Earnings O23.1 Corporation To distinguish the equity provided by investors from the equity which may be earned by the corporation, earned corporate equity is recorded in a special account, unique to corporations called retained earnings

©CourseCollege.com 22 Contributed capital & Retained Earnings O23.1 Corporation The Retained Earnings account holds the accumulated (year after year) total of earnings achieved by the corporation that were retained. That is, they were not returned to the stockholders as dividends

©CourseCollege.com 23 Objective 23.2: Account for organizing a corporation O23.2 Western Corporation is in the process of formation and sells 500 shares of stock at $10 par value

©CourseCollege.com 24 Stock sold for more than par value O23.2 Western Corporation subsequently sells 1000 shares for $15 per share ($10 par value)

©CourseCollege.com 25 Resulting corporate equity Western Corporation Contributed Capital O23.2

©CourseCollege.com 26 Sale of no par stock O23.2 Eastern Corporation is in the process of formation and sells 1500 shares of no par stock for $20 per share

©CourseCollege.com 27 Sale of no par stock O23.2 Subsequently, Eastern Corporation sells 2500 shares of no par stock for $22 per share

©CourseCollege.com 28 Resulting corporate equity Eastern Corporation Contributed Capital O23.2

©CourseCollege.com 29 Investment of assets other than cash O23.2 Eastern Corporation accepts equipment with a market value of $110,000 and issues the investor shares based on the most recent market price of $22 per share (110,000/22 = 5,000 shares)

©CourseCollege.com 30 Resulting corporate equity Eastern Corporation Contributed Capital O23.2

©CourseCollege.com 31 Closing net income for a corporation O23.2 Eastern Corporation completes its’ first year of operations with net income of $75,000 which is closed to Retained Earnings

©CourseCollege.com 32 Resulting corporate equity Eastern Corporation Contributed Capital + Retained Earnings O23.2

©CourseCollege.com 33 Sale of preferred stock O23.2 Western Corporation needs additional capital. 50 shares of $100 par 7% preferred stock are sold for $125 per share

©CourseCollege.com 34 Resulting corporate equity Western Corporation Contributed Capital O23.2

©CourseCollege.com 35 Objective 23.3: Account for cash dividends O23.3 Cash dividends Cash is paid to stockholders Must be approved by the board of directors Are not guaranteed to stockholders Are optional distributions of cash Are declared if the board believes the current financial condition and availability of cash warrants the distribution under the goals of the firm Stockholders

©CourseCollege.com 36 Dividend declaration O23.3 Eastern Corporation board of directors declares a $25,000 cash dividend on January 31

©CourseCollege.com 37 Resulting corporate equity Eastern Corporation 75,000-25,000 = 50,000 O ,000 moved from Equity to Liabilities

©CourseCollege.com 38 Date of record O23.3 Eastern Corporation’s cash dividend will be paid to those stockholders who own stock on March 1. No journal entry is made on the date of record

©CourseCollege.com 39 Date of payment O23.3 Eastern Corporation’s $25,000 cash dividend is paid on March 15

©CourseCollege.com 40 Preferred stock dividend preference O23.1 Cumulative –preferred dividends not paid in any year must be paid first in subsequent years from any cash dividends declared Non-cumulative –if no preferred dividends are paid, there is no right to receive the missed dividend in the future Participating –(rare) after receiving preferred dividends, preferred stockholders join common stockholders to share in remaining cash dividends (specifics of the sharing agreement specified in original preferred stock agreement) Non-participating –after receiving preferred dividends, preferred stockholders have no right to participate in remaining dividends with common stockholders

©CourseCollege.com 41 Dividend allocation ArticAir Corporation ArticAir has 9% cumulative and non- participating preferred O23.3

©CourseCollege.com 42 Dividend allocation O23.2 ArticAir Corporation Board of directors declares a $100,000 cash dividend on January 31 Preferred 500,000 at par x 9% = 45,000 to preferred and the balance of 55,000 to common stockholders.

©CourseCollege.com 43 Dividend allocation –preferred in arrears O23.3 For the following year 2012, ArticAir declared no dividends. For 2013, $100,000 cash dividends are declared on 1/31/14. Preferred 500,000 at par x 9% = 45,000 to preferred for 2012 plus 45,000 for the current year 2013 with the balance of 10,000 to common stockholders.

©CourseCollege.com 44 Additional preferred stock features O23.3 Convertible preferred stock allows stockholders to convert their shares into a predetermined number of common shares. These rights typically have a time window in which they must be executed. Call features allow the issuing firm to retire (repurchase) and replace the issued preferred stock Call provisions usually carry a call price, a premium above the par value that must be paid by the issuer. Convertible preferred stock allows stockholders to convert their shares into a predetermined number of common shares. These rights typically have a time window in which they must be executed. Call features allow the issuing firm to retire (repurchase) and replace the issued preferred stock Call provisions usually carry a call price, a premium above the par value that must be paid by the issuer.

©CourseCollege.com 45 Objective 23.5: Analysis: Compute and explain return on common stockholder’s equity Compares earnings available to common stockholders to the average amount of common equity O23.5 Investors are especially interested in this ratio which compare earnings to average common stockholder’s equity.

©CourseCollege.com 46 Return on common stockholders equity Earnings available to common stockholders = net income minus preferred stockholder dividends. The higher the return, the more desireable the common stock within the risk profile presented by the firm O23.5 Return on common stockholder’s equity Average common stockholder’s equity Net income – preferred dividends =

©CourseCollege.com 47 Example O23.5

©CourseCollege.com 48 End Unit 23