Download presentation
Presentation is loading. Please wait.
1
Reporting and Interpreting Owners’ Equity
Chapter 11 Chapter 11: Reporting and Interpreting Owners’ Equity.
2
Explain the role of stock in the capital structure of a corporation.
Learning Objectives Explain the role of stock in the capital structure of a corporation. LO1 Our first learning objective in Chapter 11 is to explain the role of stock in the capital structure of a corporation.
3
Understanding The Business
Advantages of a corporation Simple to become an owner Easy to transfer ownership Provides limited liability The corporate form of organization has several advantages. The major advantage is the ease of raising large amounts of money because both large and small investors can participate in corporate ownership. It is simple to become an owner of corporate shares of stock and it is just as simple to sell the shares. Organized exchanges, such as the New York Stock Exchange, maintain markets in which shares in thousands of companies are bought and sold each business day. Another advantaged is limited liability. Stockholders’ losses are limited to the amount invested in the corporation. Corporate creditors cannot make claims on the personal assets of shareholders to satisfy corporate debt.
4
Understanding The Business
Because a corporation is a separate legal entity, it can . . . Own assets. Sue and be sued. Incur liabilities. Enter into contracts. Corporations are entities created by law that exist separately from their owners and that have rights and privileges. As separate entities, corporations can: Own assets. Incur liabilities. Sue and be sued.. Enter into contracts. Stockholders are not agents of the corporation and cannot enter into contracts on the corporation’s behalf.
5
Ownership of a Corporation
Voting (in person or by proxy). Proportionate distributions of profits. Proportionate distributions of assets in a liquidation. Rights Stockholders’ In addition to voting on important issues at annual meetings, stockholders have other benefits. Stockholders have the right to receive dividends when declared by the board of directors. In the event of liquidation, stockholders share, according to their percentage ownership, in any remaining assets after creditors are paid.
6
Ownership of a Corporation
Elected by shareholders Appointed by directors Ultimate control of a corporation rests with the stockholders. At their annual meeting, stockholders elect the Board of Directors and vote on important management issues facing the company. The members of the board of directors hire the executive officers of the corporation. Finally, officers of the corporation empower others to hire needed employees. Employees, officers, and members of the board of directors may also be owners of the corporation.
7
Authorized, Issued, and Outstanding Capital Stock
Shares The maximum number of shares of capital stock that can be sold to the public. Authorized shares are the maximum number of shares of stock that can be sold to the public. The number of authorized shares is identified in the corporate charter of the corporation that is issued by the state.
8
Authorized, Issued, and Outstanding Capital Stock
Shares Issued shares are authorized shares of stock that have been sold. Unissued shares are authorized shares of stock that never have been sold. Authorized shares are either issued or unissued. Unissued shares are shares of stock that have never been sold to the public. Issued shares are shares of stock that have been sold to the public.
9
Authorized, Issued, and Outstanding Capital Stock
Treasury shares are issued shares that have been reacquired by the corporation. Outstanding shares are issued shares that are owned by stockholders. Authorized Shares Outstanding Shares Unissued Shares Issued Shares Issued shares can be classified as either outstanding shares or treasury shares. Outstanding shares are shares that have been issued and are currently owned by stockholders. Treasury shares are shares that have been issued to stockholders, but have since been repurchased by the corporation. Treasury Shares
10
Analyze the earnings per share ratio.
Learning Objectives Analyze the earnings per share ratio. LO2 Our second learning objective in Chapter 11 is to analyze the earnings per share ratio.
11
Earnings per share (EPS)
Net Income Average Number of Shares Outstanding EPS = Outback’s income for 2003 is $170,000,000 and the average number of shares outstanding is 75,260,000. Earnings per share is one of the most widely quoted financial ratios. It is a measure of the company’s ability to produce income for each common share outstanding. Earnings per share is equal to income divided by the average number of common shares outstanding. Outback Steakhouse’s income for 2003 is $170,000,000 and the average number of shares outstanding is 75,260,000. Let’s calculate Outback’s earnings per share for 2003. Earnings per share is probably the single most widely watched financial ratio.
12
Earnings per share (EPS)
Net Income Average Number of Shares Outstanding EPS = $170,000,000 75,260,000 Shares EPS = = $2.26 per share Outback’s earnings per share for 2003 is $2.26, obtained by dividing income of $170,000,000 by 75,260,000, the average number of shares outstanding for the year. Earnings per share is probably the single most widely watched financial ratio.
13
Earnings per share (EPS)
Part I. Outback has increased earnings per share from $1.63 in 2001 to $2.26 in 2003. Part II. Here we see a comparison of 2003 earnings per share for Outback and two competitors. Earnings per share is probably the single most widely watched financial ratio.
14
LO3 Learning Objectives
Describe the characteristics of common stock and analyze transactions affecting common stock. LO3 Our third learning objective in Chapter 11 is to describe the characteristics of common stock and analyze transactions affecting common stock.
15
Common Stock Preferred Stock
Types of Capital Stock Common Stock Preferred Stock There are two basic types of capital stock:: common stock and preferred stock.
16
Ranks after preferred stock Dividend set by board of directors
Common Stock Basic voting stock Ranks after preferred stock Dividend set by board of directors Common stock is the basic voting stock of the corporation. It represents the residual claim on assets in liquidation. Dividends paid must first satisfy preferred stock agreements before any distribution can be made to common stockholders.
17
Par Value and No-par Value Stock
Nominal value Legal capital Common stock normally has a par value which is usually a very small amount, typically less than one dollar per share. In states that require a par value per share, the par value is also the legal capital that must remain invested in the business. Legal capital is the amount of capital, required by the state, that must remain invested in the business.
18
Par Value and No-par Value Stock
Par Value Market Value I get it! Par value is an arbitrary amount assigned to each share of stock in the corporate charter. Par value is a nominal amount, and is not related in any manner to market value which is the selling price of a share of stock.
19
Some states do not require a par value to be stated in the charter.
No-par Value Stock Some states do not require that a par value be stated in the charter. Some states do not require a par value to be stated in the charter. In addition to par value stock, some states permit no-par value common stock.
20
Accounting for Capital Stock
Two primary sources of stockholders’ equity Retained earnings Contributed capital Corporations have two primary sources of equity. The first is contributed capital. The two accounts in contributed capital, common stock, par value, and capital in excess of par value, represent amounts that shareholders have invested by buying shares of stock from the company. The second source of equity is retained earnings. The retained earnings account reports the cumulative amount of net income the corporation has earned since its organization less the cumulative amount of dividends declared since organization. This is the portion of the net income that has been reinvested in the business rather than distributed to the owners in dividends. Common stock, par value Capital in excess of par value
21
Sale and Issuance of Capital Stock
Initial public offering (IPO) Seasoned new issue The first time a corporation sells stock to the public. Subsequent sales of new stock to the public. At the initial public offering, shares of stock are sold to the public for the first time, usually through major securities brokerage firms with retail offices in cities across the country. At a later date, the company may wish to raise additional capital with another sale of stock to the public. This is referred to as a seasoned new issue. Outback Outback issues new stock.
22
Secondary Markets Transactions between two investors that do not affect the corporation’s accounting records. I’d like to sell some of my Outback stock. I’d like to buy some of your Outback stock. Once shares of stock are owned by the public, they may be bought and sold in the open market. Such transactions do not involve the company or its accounting records. The millions of shares that are bought and sold on the New York Stock Exchange each business day are examples of this type of transaction.
23
Sale and Issuance of Capital Stock
On July 6, Outback issued 100,000 shares of $0.01 par value common stock for $22 per share. Prepare the journal entry to record this transaction. 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 capital in excess of par value. When added together, the amount of par value in the common stock account and the amount in the contributed capital in excess of par value account is equal to the market value of the sale of the stock. We will look at how to account for par value stock. Accounting entries for stated value stock is very similar to accounting for par value stock. When a company has no-par stock, all the proceeds are credited to the common stock account. Let’s look at an example. On July 6, Outback issued 100,000 shares of $0.01 par value common stock for $22 per share. Let’s prepare the journal entry to record this transaction.
24
Sale and Issuance of Capital Stock
On July 6, Outback issued 100,000 shares of $0.01 par value common stock for $22 per share. 100,000 shares × $0.01 par value = $1,000 100,000 shares × $22 per share = $2,200,000 To record this stock issue, we debit cash for the market value of the stock sold: 100,000 shares times $22 per share. We credit common stock for the par value of the share sold: 100,000 shares times $0.01 per share. Next, we credit capital in excess of par value for the excess of market over par value, $2,199,000.
25
Employee compensation package includes salary and stock options.
Outback If Outback does not have new stock to issue when the stock options are exercised, then . . Employee compensation package includes salary and stock options. Stock options allow employees to purchase stock from the corporation at a fraction of the stock’s value in the secondary market. Many corporations have employee compensation packages that include both salary and stock options. Most stock option plans allow employees to buy shares of stock from the corporation at a discount to the market price. Stock option compensation plans can motivate employees to increase financial performance which can increase the stock price. All investors in the company benefit when the stock price increases. If the company granting the options to its employees does not have unissued shares of stock to sell to employees when the stock options are exercised, the company can buy the shares in the open market. Employee
26
Treasury Stock Outback buys its own stock in Outback
Stockholders the secondary market. (Treasury stock) Management compensation package includes salary and stock options. Stock options allow management to purchase stock from the corporation at a fraction of the stock’s value in the secondary market. Outback buys its own shares from current stockholders in a secondary market to make them available for employee stock option plans. The repurchased shares are called treasury stock. In addition to repurchasing shares for employee stock option plans, companies buy their own stock to support the market price, to increase shares needed to use in the acquisition of another company, to limit the shares available for a hostile takeover, and to return cash to shareholders who wish to sell their shares. Management
27
No voting or dividend rights
Treasury Stock No voting or dividend rights Contra equity account Treasury stock has no voting or dividend rights. Treasury stock is not an asset. It is a contra equity account and is subtracted from the stockholders’ equity section on the balance sheet. Treasury stock is usually recorded at the cost to purchase it, and the total cost of all shares of treasury stock held by the company is the amount reported as a reduction in stockholders’ equity. Let’s look at an example. When stock is reacquired, the corporation records the treasury stock at cost.
28
The journal entry for May 1 is . . . .
Treasury Stock On May 1, Outback reacquired 100,000 shares of its common stock at $20 per share. The journal entry for May 1 is On May 1, Outback reacquired 100,000 shares of its common stock at $20 per share. The journal entry for May 1 requires a debit to treasury stock and a credit to cash for the cost of the shares, 100,000 shares times $20 per share equals $2,000,000.
29
The journal entry for December 3 is . . .
Treasury Stock On December 3, Outback reissued 10,000 shares of the treasury stock at $30 per share. The journal entry for December 3 is . . . 10,000 shares × $20 cost = $200,000 10,000 shares × $30 = $300,000 On December 3, Outback reissued 10,000 shares of the treasury stock for $30 per share. Remember that the original cost of the treasury stock was $20 per share. The entry to record the sale of the treasury stock includes a debit to cash for $300,000, a credit to treasury stock for $200,000, and a credit to capital in excess of par value for $100,000. The credit to treasury stock is the original cost of $20 per share times the 10,000 sold. The difference between the selling price and the cost of the treasury stock is the credit to capital in excess of par value. No profit or loss is recognized on treasury stock transactions.
30
Discuss dividends and analyze transactions.
Learning Objectives Discuss dividends and analyze transactions. LO4 Our fourth learning objective in Chapter 11 is to discuss dividends and analyze transactions.
31
Accounting for Cash Dividends
Declared by board of directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. Cash dividends are declared by the board of directors. There is no legal obligation to declare a cash dividend, but once declared, there is a legal obligation to pay the dividend. Most corporations that pay cash dividends pay them quarterly. To pay a cash dividend, a corporation must have two things: Sufficient retained earnings to absorb the dividend without going negative and Enough cash to pay the dividend.
32
Dividend Dates Declaration date
Board of directors declares the dividend. Record a liability. There are three important dates to remember when discussing dividends: The date of declaration. The date of record. The date of payment. The date of declaration is the date the directors declare the dividend. At this time a liability is created and must be recorded. The entry at the date of declaration includes a debit to retained earnings and a credit to dividends payable.
33
Dividend Dates Date of Record X
Stockholders holding shares on this date will receive the dividend. (No entry) The date of record is important because it is the date when the corporation determines the owners of record who will receive the dividend. No entry is required in the accounting records on this date. X
34
Dividend Dates Date of Payment
Record the dividend payment to stockholders. The date of payment is the date the corporation pays the dividend to the stockholders who owned the stock on the record date. The entry on the date of payment includes a debit to dividends payable and credit to cash for the total amount of cash paid to the owners of record.
35
Analyze the dividend yield ratio.
Learning Objectives Analyze the dividend yield ratio. LO5 Our fifth learning objective in Chapter 11 is to analyze the dividend yield ratio.
36
Dividend Yield Ratio Dividend Yield Dividends Per Share
Market Price Per Share = Outback paid a dividend of $0.12 per share in 2003 and the market price was $40 per share. Investors are interested in the amount of income that they will receive in the form of dividends. One comparison that investors make is based on dividend yield. To calculate the dividend yield ratio, we divide the annual dividend per share by the market price per share of the company’s common stock. During 2003, Outback paid a dividend of $0.12 per share of common stock outstanding at a time when the market price per share of its common stock was $40. Let’s compute Outback’s dividend yield ratio. This ratio is often used to compare the dividend-paying performance of different investment alternatives.
37
Dividend Yield Ratio Dividend Yield Dividends Per Share
Market Price Per Share = Dividend Yield $0.12 $40.00 = = 0.3% We divide the $0.12 dividend by $40 market price to obtain a dividend yield of 0.3 percent. This ratio is often used to compare the dividend-paying performance of different investment alternatives.
38
Dividend Yield Ratio Part I. Outback’s dividend yield has increased from zero percent in 2001, when no dividend was paid, to 0.3 percent in 2003. Part II. Outback has a higher dividend yield that two of its competitors. This ratio is often used to compare the dividend-paying performance of different investment alternatives.
39
LO6 Learning Objectives
Discuss the purpose of stock dividends, stock splits, and report transactions. LO6 Our sixth learning objective in Chapter 11 is to discuss the purpose of stock dividends, stock splits, and report transactions.
40
Accounting for Stock Dividends
Distribution of additional shares of stock to stockholders. No change in total stockholders’ equity. All stockholders retain same percentage ownership. No change in par values. A stock dividend is a distribution of additional shares of stock to stockholders. All stockholders retain the same percentage ownership. The stockholders have more shares of stock representing the same ownership as they had before the stock dividend. There is no change in total stockholders’ equity and par value per share does not change. Why do corporation issue stock dividends which are merely more pieces of paper evidencing the same percentage ownership? Corporations may issue stock dividends to: Reduce the market price per share of stock to make the shares more affordable for investors to purchase. Signal that the management expects strong financial performance in the future.
41
Accounting for Stock Dividends
Small Large Stock dividend < 25% Stock dividend > 25% Record at current market value of stock. Record at par value of stock. A stock dividend can be classified as small or large. A small stock dividend is a distribution of stock that is less than 25 percent of the outstanding shares. Small stock dividends are recorded at the market value of the stock. A large stock dividend is a distribution of stock that is greater than 25 percent of the outstanding shares. Large stock dividends are recorded at the par value of the stock.
42
Banana Splits On Sale Now
Stock Splits Stock splits change the par value per share, but the total par value is unchanged. Ice Cream Parlor Banana Splits On Sale Now A stock split is the distribution of additional shares of stock to stockholders according to their percent ownership. When a stock split occurs, the corporation calls in the outstanding shares and issues new shares of stock. In the process of a stock split, the par value per share of the stock changes. Each shareholder has the same percentage ownership of the company after the split as before the split. So we sometimes say that a stock split creates more, but smaller, pieces of the same pie. Let’s look at an example.
43
Stock Splits Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split. Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split. What are the number of shares, the par value per share, and the total par value after the split?
44
Stock Splits Assume that a corporation had 3,000 shares of $2 par value common stock outstanding before a 2–for–1 stock split. Increase After the two-for-one split, the number of shares doubled and the par value was cut in half. Notice that an accounting entry is not required, and that retained earnings is not reduced. In many respects a 100 percent stock dividend and a two-for-one stock split result in similar impacts to the price per share in the stock market. The stock split usually requires more administrative tasks to call in and reissue stock certificates. Decrease No Change
45
LO7 Learning Objectives
Describe the purpose of preferred stock and analyze transactions affecting preferred stock. LO7 Our seventh learning objective in Chapter 11 is to describe the purpose of preferred stock and analyze transactions affecting preferred stock.
46
Preference over common stock
Preferred Stock Preference over common stock Usually has no voting rights Usually has a fixed dividend rate Preferred stock is a separate class of stock that typically has priority over common stock in dividend distributions and distribution of assets in a liquidation. Preferred stock usually has a stated dividend that is expressed as a percentage of its par value. It normally does not have voting rights and is often callable by the corporation at a stated value.
47
Dividends on Preferred Stock
Current Dividend Preference: The current preferred dividends must be paid before paying any dividends to common stock. Cumulative Dividend Preference: Any unpaid dividends from previous years (dividends in arrears) must be paid before common dividends are paid. Preferred stock has a current dividend preference when compared to common stock. Current preferred dividends must be paid to preferred stockholders before any dividends are paid to common stockholders. Cumulative preferred stockholders have the right to be paid both the current and all prior periods’ unpaid dividends before any dividends are paid to common stockholders. When the preferred stock is cumulative and the directors do not declare a dividend to preferred stockholders, the unpaid dividend is called a dividend in arrears and must be disclosed in the financial statements.
48
Dividends on Preferred Stock
If the preferred stock is noncumulative, any dividends not declared in previous years are lost permanently. Noncumulative preferred stock has no rights to prior periods’ dividends if they were not declared in those prior periods. Let’s look at an example.
49
Dividends on Preferred Stock
Kites, Inc. has the following stock outstanding: Common stock: $1 par, 100,000 shares Preferred stock: 3%, $100 par, cumulative, 5,000 shares Preferred stock: 6%, $50 par, noncumulative, 3,000 shares Dividends were not paid last year. In the current year, the board of directors declared dividends of $50,000. How much will each class of stock receive? Kites, Inc. has the following stock outstanding: Common stock: $1 par, 100,000 shares Preferred stock: 3%, $100 par, cumulative, 5,000 shares Preferred stock: 6%, $50 par, noncumulative, 3,000 shares Dividends were not paid last year. In the current year, the board of directors declared dividends of $50,000. How much will each class of stock receive? Note that this company has both common stock and two classes of preferred stock. Let’s see how the $50,000 dividend is distributed.
50
Dividends on Preferred Stock
Recall that preferred stockholders receive any declared dividends before common stockholders. In addition, cumulative preferred stockholders have rights to the dividends in arrears from last year in addition to the current year’s dividends.
51
Dividends on Preferred Stock
First, let’s compute the amount of dividends in arrears on the preferred stock. This amount will be paid before any other dividend consideration. The cumulative preferred stockholders have rights to the dividends in arrears from last year in addition to dividends for the current year. The arrearage for last year is $15,000 computed by multiplying 3 percent times the $100 par value times 5,000 shares. The current year’s dividend on the cumulative preferred is also $15,000. Of the original total $50,000 dividend, we now have $20,000 remaining for the noncumulative preferred and the common.
52
Dividends on Preferred Stock
Next, let’s calculate the noncumulative preferred dividend for the current year. It must be paid before common stockholders receive a dividend. The current year’s dividend on the noncumulative preferred is $9,000 computed by multiplying 6 percent times the $50 par value times 3,000 shares. Of the original total $50,000 dividend, we now have $11,000 remaining for the common stockholders.
53
Dividends on Preferred Stock
The remaining $11,000 is distributed to common stockholders. Now, let’s look at a question about dividend declarations.
54
Dividends on Preferred Stock
On June 1, 2003, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. On June 1, 2003, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Prepare the journal entry to record the dividend payment on July 15, and then select the correct answer from the four choices.
55
Dividends on Preferred Stock
On June 1, 2000 a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. $100 × 8% = $8 dividend per share $8 × 2,500 = $20,000 total dividend The correct answer is choice b. The dividend declaration on June 1 created a dividend payable liability of $20,000 computed by multiplying 8 percent times the $100 par value times 2,500 shares. Dividends payable has a credit balance. When the dividend is paid on July 15, we debit dividends payable for $20,000 to remove the liability.
56
Restrictions on Retained Earnings
If I loan you $150,000, I will want you to restrict your retained earnings. Why would you want to do that? 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.
57
Discuss the impact of capital stock transactions on cash flows.
Learning Objectives Discuss the impact of capital stock transactions on cash flows. LO8 Our eighth learning objective in Chapter 11 is to discuss the impact of capital stock transactions on cash flows.
58
Focus on Cash Flows Outback
Issuing stock for cash and selling treasury stock for cash results in cash inflows. Purchasing treasury stock with cash and paying cash dividends results in cash outflows. These cash flows are reported in the financing activities section of the statement of cash flows. Outback
59
Chapter Supplement A Accounting for Owners’ Equity for Sole Proprietorships and Partnerships Chapter Supplement A: Accounting for Owners’ Equity for Sole Proprietorships and Partnerships.
60
A sole proprietorship is owned by a one person.
Sole Proprietorships A sole proprietorship is owned by a one person. Two equity accounts In addition to corporations, there are two other forms of business organizations: sole proprietorships and partnerships. A sole proprietorship is owned by one person. There are two equity accounts for a sole proprietorship: capital and drawings. Capital is the equivalent of common stock and retained earnings combined for a corporation. Drawings are the equivalent of dividends for a corporation. Let’s look at an example. Capital Drawings
61
Sole Proprietorships On January 2, J. Doe started a retail store by investing $150,000 of his own money. The journal entry to record this business formation is: On January 2, J. Doe started a retail store by investing $150,000 of his own money. The journal entry on the books of the proprietorship to record this business formation is a debit to cash and a credit to J. Doe, Capital for $150,000.
62
Sole Proprietorships Each month, J. Doe withdraws $1,000 for personal living expenses. The January 30 journal entry to record the first withdrawal is: Each month, J. Doe withdraws $1,000 from the business for personal living expenses. The January 30 journal entry to record the first withdrawal is a debit to J. Doe, Drawings and a credit to cash for $1,000.
63
Sole Proprietorships During the first year, J. Doe’s income totaled $18,000, and his withdrawals totaled $12,000. The equity section of J. Doe’s balance sheet at the end of the first year is: During the first year, J. Doe’s income totaled $18,000, and his withdrawals totaled $12,000. The equity section of J. Doe’s balance sheet at the end of the first year shows an ending balance in the capital account of $156,000. We arrive at this amount by adding the $18,000 of income to the $150,000 beginning capital balance and subtracting the $12,000 of drawings from the total.
64
A partnership is owned by two or more individuals.
Partnerships A partnership is owned by two or more individuals. Partnerships require clear agreements about authority, risks, and the sharing of profits and losses. Separate capital and drawings accounts are maintained for each partner. A partnership is owned by two or more individuals. Partnerships require clear agreements about authority, risks, and the sharing of profits and losses. Separate capital and drawings accounts are maintained for each partner. Partnership income is divided among the partners according to the partnership agreement. Partnership income is divided among the partners according to the partnership agreement.
65
Partnerships Advantages Ease of formation Complete control by partners
No income taxes on business Primary disadvantage Partnerships have some advantages and disadvantages when compared to corporations. The primary advantages are ease of formation, complete control by the partners, and the avoidance of income taxes on the partnership income. Each partner pays taxes at his or her share of partnership income. The primary disadvantage of a partnership is unlimited liability. Creditors can make claims against partners’ personal assets to satisfy partnership debts. Let’s look at an example. Unlimited liability
66
Partnerships On January 2, Able and Baker formed a partnership. Able contributed $60,000 cash. Jones contributed $40,000 cash. The partners agreed to divide partnership income in the ratio of their contributions (60:40). The journal entry to record this business formation is: On January 2, Able and Baker formed a partnership. Able contributed $60,000 cash. Jones contributed $40,000 cash. The partners agreed to divide partnership income in the ratio of their contributions (60:40). The journal entry to record this business formation on the books of the partnership is a debit to cash for $100,000, a credit to Able, Capital for $60,000, and a credit to Baker, Capital for $40,000.
67
Partnerships The partners agreed that each month Able would withdraw $1,000 and Baker would withdraw $650. The January 30 journal entry to record the first withdrawal is: The partners agreed that each month Able would withdraw $1,000 and Baker would withdraw $650. The January 30 journal entry to record the first withdrawal is a debit to Able, Drawings for $1,000, a debit to Baker, Drawings for $650, and a credit to cash for $1,650.
68
Partnerships During the first year, partnership income totaled $30,000. Withdrawals totaled $12,000 for Able and $7,800 for Baker. The equity section of the partnership balance sheet at the end of the first year is: During the first year, partnership income totaled $30,000. The $30,000 of partnership income is credited to the partners’ capital accounts in the agreed upon 60:40 ratio, with Able receiving $18,000 and Baker receiving $12,000. Withdrawals totaled $12,000 for Able and $7,800 for Baker. The equity section of the partnership balance sheet at the end of the first year shows ending capital balances of $66,000 for Able and $44,200 for Baker. We get these amounts similar to the way we did for the proprietorship, by adding investments and income to the beginning capital balances and deducting withdrawals from the total.
69
Accounting and Reporting for Three Types of Businesses
Here’s a convenient summary of the accounting and reporting issues for the three forms of business that we have discussed in this chapter.
70
End of Chapter 11 End of Chapter 11.
Similar presentations
© 2025 SlidePlayer.com. Inc.
All rights reserved.