2. Corporations: Formation and Capital Stock Transactions
Chapter 20
Corporations: Formation and Capital Stock Transactions
Section 1: Forming a Corporation
Section Objectives
Chapter 19 discussed accounting for partnerships. Chapter 20 begins the discussion of corporations, the final form of business organization to be addressed. This is our first chapter dealing with corporations. In this first section we will discuss the characteristics of a corporation and a look at some hybrid organizations.
Explain the characteristics of a corporation.
Describe special “hybrid” organizations that have some characteristics of partnerships and some characteristics of corporations.
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© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

3. Explain the characteristics of a corporation
Objective 1
Explain the characteristics of a corporation
Created by corporate charter issued by state government.
Can enter into contracts and own property.
Can have few or many owners.
Can be privately held or publicly held.
Let’s look at the common characteristics of a corporation.
A corporation is considered an artificial person in the eyes of the law. As a separate legal entity, it owns assets and is responsible for paying corporate liabilities.
Corporations can have a single owner or it can be owned by millions.
An owner of a corporation is called a shareholder because they have purchased shares of the company’s stock.

4. Corporations Advantages Disadvantages Limited liability
Corporate income tax
Restricted agency
Governmental regulation
Continuous existence
Transferability of ownership rights
There are many advantages and there are also some disadvantages of forming a business as a corporation.
Some of the advantages are:
Limited liability--Shareholders have no personal liability for the corporation’s debts.,
Restricted agency--A shareholder has no right to act on behalf of the corporation. Instead, the board of directors controls the corporation and management controls its operations.,
Continuous existence--If a shareholder dies, it has no effect on the corporation’s life.,
Transferability of ownership rights--If you don’t want to be an owner anymore, all you have to do is sell your shares., and
Ease of raising capital--If a company wants to raise capital, it can sell more stock.
Some of the Disadvantages are: Corporate income tax--A corporation’s income is taxed at both the corporate level as well as the shareholder level. and
Governmental regulation--State regulatory bodies exercise closer supervision and control over corporations. (A corporation has to renew its state charter every year, if it is publicly traded--it must be audited, the SEC requires quarterly reports, etc.).
Ease of raising capital

5. “Hybrid” Business Entities
Objective 2
Describe special “hybrid” organizations
“Hybrid” Business Entities
Subchapter S corporation.
Limited liability partnership (LLP).
Limited liability company (LLC).
Some businesses have characteristics of partnerships and of corporations. Entities that have attributes of both partnerships and corporations are Subchapter S corporations, Limited liability partnerships (LLP) and Limited liability companies (LLC). These are all considered to be hybrid business entities.
Hybrid entities have characteristics of partnerships and corporations.

6. Subchapter S Corporation
Known as S corporation.
Meets Subchapter S requirements of Internal Revenue Code to be treated as a partnership.
The S corporation does not pay income taxes.
Subchapter S Corporations
These corporations are treated essentially as a partnership so the corporation pays no income tax. Instead, shareholders include their share of corporate profits on their personal income tax returns. (They receive a k-1 form from the corp. at year end.) S corporations have all the characteristics of a regular corporation, like shareholder limited liability, but they avoid the double taxation disadvantage.
Shareholders include their share of corporate profits on their individual tax returns.

7. Limited Liability Partnership (LLP)
Partners are responsible and have liability for their own actions and actions of those they control or supervise.
Partners are not liable for the actions or malfeasance of another partner.
LLP partners are responsible and have liability for their own actions and the actions of those under their control or supervision. (They are not responsible for the actions of another partner.)

8. Limited Liability Company (LLC)
Owners have limited liability.
Owners choose to have profits taxed at the company level or on their individual income tax return.
Profits and losses can be allocated other than in proportion to ownership interest.
Transfers of ownership must be approved by owners.
Limited Liability Companies
Provide limited liability to the owners. The entity may elect to be taxed as a corporation. Ownership is not freely transferable.

9. After a Corporate Charter Is Issued
Organizers elect an acting board of directors.
Shares are issued to individuals who have paid full purchase price of the stock.
Shareholders elect permanent directors.
Directors or shareholders approve bylaws.
Unlike a proprietorship or a partnership, a corporation cannot just open its doors and begin business operations. Permission must be obtained from the state. In addition, the new corporation may have to register with various taxing authorities.
The general formation steps include:
A corporate charter must be filed. (specifies name, length of life, rights and duties, scope of operation, classes of stock and number of shares in each class.)
Board of directors is elected.
Corporation issues shares of stock in exchange for cash or other assets.
The stockholders elect a permanent set of directors. (The directors or shareholders approve the corporation’s bylaws.)
The directors select officers who will hire employees so that the company can begin doing business.
Board selects corporate officers.
Officers hire employees and begin operations.

10. Corporations: Formation and Capital Stock Transactions
Chapter 20
Corporations: Formation and Capital Stock Transactions
Section 2: Types of
Capital Stock
Section Objectives
Corporations raise money by borrowing the money, or by selling shares of stock. This section describes the recordkeeping involved with issuing shares of stock and paying dividends.
Describe the different types of stock.
Compute the number of shares of common stock to be issued on the conversion of convertible preferred stock.
5. Compute dividends payable on stock.
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© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

11. Capital Stock
Authorized shares: The number of shares that can be sold.
Issued shares: The number of shares that have been sold.
Outstanding shares: The number of shares still in circulation.
Outstanding stock = Issued stock – Treasury stock
When a corporation is formed, the individuals who file the corporate charter with the state must first determine the maximum number of shares the corporation will be authorized to issue. Authorized stock must allow for future flexibility so usually the authorized stock is more than the number of shares the corporation plans to issue in the foreseeable future.
Let’s look at the various definitions of capital stock. The maximum number of shares which can be issued is authorized stock. Stock that has been sold is considered issued stock. And, stock that is still in the hands of outsiders is considered outstanding stock.

12. Capital Stock Values Par Value Stated Value Market Value
Specified in the corporate charter and assigned to each share of stock for accounting purposes.
Stated Value
A value assigned to no-par stock by the board of directors for accounting and legal purposes.
Capital stock has different types of “values”. A stock may have a par value, a stated value and a market value.
Par value is assigned to each share of stock for accounting purposes. Generally, it is the minimum amount a share can be sold for.
Stated value is assigned to a stock which does not have a par value. It is treated the same as par value.
Market value is the price per share at which the stock is bought or sold.
Market Value
The price per share at which stock is bought and sold.

13. Stock Classes Describe the different types of stock Common Preferred
Objective 3
Describe the different types of stock
Stock Classes
Common
Preferred
If there is only one class of stock, common stock is issued. Each share carries the same rights and privileges as every other share.
Preferred stock has special claims on a corporation’s profits or, in case of liquidation, corporate assets.
There are different types of stock that a corporation may issue. Each type or class of stock has different rights and privileges. If a corporation only issues one class of stock then it would be common stock. Preferred shareholders usually cannot vote.
Preferred stock has several preferences over the rights of common stockholders which include the right to receive dividends before common stockholders receive any. They also have preferential rights to the company assets before common stockholders, if the company ceases doing business.

14. Objective 4
Compute the number of shares of common stock to be issued on the conversion of convertible preferred stock.
Some preferred stock can be converted into shares of common stock. Let’s see how to account for this. . .
Convertible preferred stock is preferred stock that conveys the right to convert that stock to common stock after a specified date or during a period of time.

15. Convertible Preferred Stock
Owners have the right to convert their shares into common stock after a specified date.
Conversion
Ratio
The number of shares of common stock into which a preferred stock can be converted.
The common stock conversion ratio will be indicated on the preferred stock certificate. (In this example 2 shares of common stock will be issued for every share of preferred stock owned. If a person owned 400 shares of preferred stock before the conversion, they would own 800 shares of common stock after the conversion.)
The conversion feature makes the preferred stock more attractive to investors.
If a stock is callable, then the corporation has the right to repurchase it from the owner at a specified price. Callable stock gives the corporation flexibility in controlling its capital structure.
Example:
400 shares of preferred, with a 1:2 conversion ratio equals 2 shares of common for each share of preferred.
400 X 2 = 800 shares of common stock

16. The board of directors declares dividends.
Objective 5
Compute dividends payable on stock
QUESTION:
What are dividends?
Dividends are distributions of the profits of a corporation to its shareholders.
ANSWER:
Dividends are a return on the common or preferred shareholder’s investment.
Dividends must be declared by the board of directors and there must be a credit balance in retained earnings large enough to cover the declared dividends.
The board of directors declares dividends.

17. Dividend Rights on Preferred Stock
Cumulative preferred stock
Noncumulative preferred stock
Nonparticipating preferred stock
Participating preferred stock
Preferred stock has a specified dividend rate (preference dividend) that must be paid before dividends can be paid to common stockholders.
The Dividend = (par value of preferred stock x dividend rate)
There are various rights which a preferred shareholder MAY have. When they purchased their shares of preferred stock, the stock certificate may have specified that dividends were: cummulative, noncummulative, nonparticipating or participating.

18. Cumulative Preferred Stock
Has right to receive preference dividend each year before any dividend can be paid on common stock.
If dividend is passed (not paid) in one year, the amount not paid carries over and must be fully paid in a subsequent year before any dividend can be paid on common stock.
If dividends are cummulative then the stockholder has the right to receive preference dividend each year before any dividend can be paid on common stock.
If dividends are passed (not paid) in one year, the amount not paid carries over and must be paid in a subsequent year before any dividend can be paid to common stockholders.

19. Noncumulative Preferred Stock
Has right to receive preference dividend each year before any dividend can be paid on common stock.
Stockholders have no rights to dividend for years in which none were declared.
If dividends are noncummulative then the stockholder has the right to receive preference dividends each year before any dividends can be paid to common stockholders but they have no rights to dividends for years in which none were declared.

20. Nonparticipating Preferred Stock
Has right to receive preference dividend each year before any dividend can be paid on common stock.
Does not have the right to any dividend in excess of the preference dividend.
If dividends are nonparticipating then the stockholder has the right to receive preference dividends each year before any dividends can be paid on common stockholders but they do not have the right to any dividends in excess of the preference dividend.

21. Participating Preferred Stock
Has right to receive preference dividend each year before any dividend can be paid on common stock.
After common shareholders have received specified amount, preferred and common stock share in further dividends.
If dividends are participating then the stockholder has the right to receive preference dividends each year before any dividends can be paid on common stockholders and after common shareholders have received their specified amount, preferred and common stock share in further dividends. Cumulative participating preferred shareholders have all the “extras.” Their dividends are paid before any other dividends are paid.

22. Common Stock
Common stockholders receive remaining dividends only after dividends have been paid on preferred stock in accordance with contractual obligations.
Common stockholders receive remaining dividends only after dividends have been paid on preferred stock in accordance with contractual obligations.

23. Dividend Calculations
The following slides show three scenarios:
Only common stock issued and 5 percent dividend declared.
Common stock and noncumulative, nonparticipating preferred stock issued and $20,000 dividend declared.
Common stock and noncumulative, nonparticipating preferred stock issued and $9,000 dividend declared.
Let’s look at these three dividend scenarios. . .

24. Only Common Stock Issued
Scenario A:
15,000 shares issued, authorized, and outstanding
$50 par value
5% dividend declared
QUESTION:
What is the dividend calculation?
15,000 shares
X $ par value
In scenario A, 15,000 shares of common stock are issued, authorized and outstanding. Each share has a $50 par value. When a 5% dividend is declared, each stockholder is entitled to $50 x 5% or $2.50 each. If we multiply the 15,000 shares outstanding x $2.50 per share then the total dividends = $37,500.
$ 750,000
X dividend declared
ANSWER:
$ 37,500 total dividends

25. Common and Noncumulative, Nonparticipating Preferred Stock Issued
Preferred Stock, noncumulative, nonparticipating
(10%, $50 Par Value, 1,000 Shares) $ 50,000
Common Stock ($20 Par Value, 10,000 Shares) ,000
Total Capital Stock $250,000
Scenario B:
Dividend declared $ 20,000
In scenario B, there are 1,000 shares of $50 par value, 10% preferred shares outstanding. If $20,000 of dividends is declared then each preferred shareholder would be entitled to: $50 x 10% which is equal to $5. Remember that preferred shareholders would get dividends before common stockholders would get any. Total dividends which preferred shareholders would be entitled to would be 1,000 shares x $5 = $5,000. The remaining $15,000 of the declared dividends would go to common stockholders.
Dividend due to preferred stockholders
(1,000 Shares x $50 x 10%) $ 5,000
Remaining dividend to common stockholders $ 15,000
Dividend per share for common stock = $15,000 ÷ 10,000 shares = $1.50

26. Common and Cumulative, Nonparticipating Preferred Stock Issued when $2,000 of preferred dividends are in arrears.
Scenario C:
Preferred Stock, noncumulative, nonparticipating
(10%, $50 Par Value, 1,000 Shares) $ 50,000
Common Stock ($20 Par Value, 10,000 Shares) ,000
Total Capital Stock $250,000
Dividend declared $ 9,000
In scenario C, there is 1000 shares of 10%, $50 par value preferred shares outstanding. In addition, the preferred shareholders are entitled to $2,000 of dividends from last year, which were not paid. Preferred shareholders are entitled to $50 x 10% x 1000 shares = $5,000 of dividends for the current year plus $2,000 from the previous year. If $9,000 of dividends is declared, the preferred shareholders would get their $7,000 first, and the remaining $2,000 would be distributed to the common stockholders.
Dividend due to preferred stockholders:
Dividends in arrears $ 2,000
(1,000 Shares x $50 x 10%) $ 5,000
Remaining dividend to common stockholders $ 2,000
Dividend per share of common stock is $2,000 ÷ 10,000 shares = $0.20

27. Capital Stock on the Balance Sheet
Capital stock represents the equity in a corporation.
Common stock and preferred stock are reported separately.
Since the owners of a corporation are stockholders, the equity section of the balance sheet is titled “Stockholders’ Equity.”
Capital stock represents the equity in a corporation and is thus reported on the balance sheet.
Common stock and preferred stock are reported separately, so readers of the financial statement will have an understanding of who owns the corporation.
Since the owners of a corporation are stockholders, the equity section of the balance sheet is titled “Stockholders’ Equity”

28. Corporations: Formation and Capital Stock Transactions
Chapter 20
Corporations: Formation and Capital Stock Transactions
Section 3: Recording
Capital Stock Transactions
Section Objectives
This last section of chapter 20 shows how to record the issuance of capital stock under various scenarios.
Record the issuance of capital stock at par value.
Prepare a balance sheet for a corporation.
Record organization costs.
9. Record stock issued at a premium, and stock with no par value.
10. Record transactions for stock subscriptions.
11. Describe the capital stock records for a corporation.
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© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

29. Recording the Issuance of Stock
Objective 6
Record the issuance of capital stock at par value
Recording the Issuance of Stock
Stock is issued after the purchaser has paid for it in full with one of the following:
Cash
Noncash assets
Services rendered
Now we are going to learn how to journalize the issuance of stock.
Stocks are issued either with or without par value. In most states, Par value is the minimum amount that the stock can be “sold” for.

30. Stock Issued at Par Value for Cash
When stock is issued for cash equal to the par value of the shares, cash proceeds are credited to the capital stock account.
20--
Dec
Cash ($15,000 + $40,000) ,000.00
Common Stock (600 X $25) ,000.00
Preferred Stock (400 X $100) ,000.00
Issuance of stock to Karen Wilcox:
600 shares of common at par
($25 per share) and 400 shares of
preferred at par ($100 per share).
Common and Preferred Stock accounts are credited for par if the stocks carry a par or a stated value. Any amounts received in excess of the par value are credited to another equity account, Paid-in Capital in Excess of Par.

31. Stock Issued at Par Value for Noncash Assets
Noncash assets include:
Merchandise Inventory
Land
Building
Equipment and Fixtures
Accounts Receivable
If Non-cash assets are received in exchange for stock, then the assets are recorded at their appraised value.
The Allowance for Doubtful Accounts is recorded separately.
The net value of assets transferred is the sum of all noncash assets less liabilities (such as Accounts Payable).

32. Camping Supply Center, Inc. Balance Sheet (Partial)
Objective 7
Preparing a Balance Sheet for a Corporation
Camping Supply Center, Inc.
Balance Sheet (Partial)
December 31, 20--
Liabilities and Stockholders’ Equity:
Current Liabilities
Accounts Payable $19,200.00
Stockholders’ Equity
Preferred Stock (10%, $100 par value,
8,000 shares authorized)
At Par Value (1,600 shares issued) $160,000.00
Common Stock ($25 par value, 40,000
shares authorized)
At Par Value (5,300 shares issued) ,500.00
Total Stockholders’ Equity ,500.00
Total Liabilities and Stockholders’ Equity $311,700.00
The balance sheet for a corporation is very similar to other balance sheets we have already seen.
The biggest difference between the corporate balance sheet and the balance sheets for sole proprietorships is the Stockholder Equity section. In this partial balance sheet, we see the Stockholders’ Equity section. Notice that the number of shares authorized and the number of shares issued is also entered in the stockholder equity section next to each class of stock.

33. Record organization costs
Objective 8
Record organization costs
Organization costs are charged to an intangible asset account and then amortized over a period of time.
20--
Dec
Organization Expenses ,000.00
Cash ,000.00
Payment of legal fees, charter fee, and cost of printing stock certificates.
When a corporation is formed it incurs many organization costs. Organization costs are costs associated with establishing a corporation such as legal fees, attorneys’ fees, charter fees, and costs of the organizational meeting with the directors.
The usual practice today is to expense organization costs during the first financial reporting period after the corporation begins activities. If stock is issued in exchange for services performed in getting the corporation ready for business, then the FMV of the services is debited to Organizational Expense.

34. Record stock issued at a premium and stock with no par value
Objective 9
Record stock issued at a premium and stock with no par value
When stock is issued for more than its par value, it is issued at a premium.
Premiums on stock are usually credited to an account titled Paid-in Capital in Excess of Par Value.
Separate accounts are set up for different classes of stock.
20--
Mar
Cash ,000.00
Preferred Stock ,000.00
Paid-in Capital in Excess of Par Value—Preferred Stock ,000.00
Issuance of 400 shares
for $105 per share
When stock is issued for more than its par value, it is issued at a premium.
Premiums on stock are usually credited to an account titled Paid-in Capital in Excess of Par Value.
Separate accounts are set up for different classes of stock. In this case $2,000 extra was received in excess of the preferred stock’s par amount. This $2,000 is credited to the Paid-in Capital in Excess of Par Value—Preferred Stock account.

35. Recording Rules for Par and No-Par Stock
Par-Value Stock
No-Par-Value Stock
Stated Value
No Stated Value
Par value is specified in corporate charter.
Stock certificate indicates par value.
Stated value is assigned by directors. Corporate charter indicates that stock is no-par-value stock.
Stock certificate does not generally show stated value.
Corporate charter indicates that stock is no-par-value stock.
Stock certificate shows that stock is no-par-value stock.
Some states allow the issuance by a corporation of stock that does not have a specified par value. This stock would be called No-par-value stock.
The table outlines the rules for recording par and no-par stock. Notice there are two columns under the No-par-value stock heading-- “Stated Value” and “No Stated Value”. There are many states that do not allow the issuance of no-par value stock and so the corporation must assign it a “stated value”. Stated value is treated the same as “par value”.

36. Recording Rules for Par and No-Par Stock (cont.)
Par-Value Stock
No-Par-Value Stock
Stated Value
No Stated Value
Change in par value requires revision of charter.
On issue of stock, par value is credited to capital stock account.
Stated value can be changed by directors.
On issue of stock, stated value is credited to capital stock account.
On issue of stock, entire proceeds are credited to capital stock account.
The table is continued here.

37. Recording No-Par-Value Stock Without a Stated Value
Stated value has not been assigned the shares.
First issue was for 1,000 shares for $20 per share.
Second issue was for 600 shares for $22 per share.
First issue: Cash ,000.00
Common Stock ,000.00
Issue of 1,000 shares
of no-par-value common
stock at $20 per share.
Second issue: Cash ,200.00
Common Stock ,200.00
Issue of 600 shares
of no-par-value common stock at $22 per share.
If no-par common stock is issued without a stated value, the entire amount received is credited to the Common Stock account.
All proceeds go into the stock accounts!!

38. Recording No-Par-Value Stock With a Stated Value
Sold 2,400 shares of stated value $25 per share stock for $26 per share.
Cash ,400.00
Common Stock ,000.00
Paid-in Capital in Excess
of Stated Value ,400.00
Issued 2,400 shares of
common stock at
$26 per share.
No-par stock with a stated value is accounted for as though the stated value is its par value. Notice that the excess cash received beyond the stated value of the stock is credited to a new account called, Paid-in Capital in Excess of Stated Value.
Stated value is credited to the capital stock account—just like par.
2,400 X $25 = $60,000

39. Subscriptions for Capital Stock
Objective 10
Record transactions for stock subscriptions
Subscriptions for Capital Stock
Stockholder signs a subscription contract. (It details stock price and payment plan.)
Stockholder pays for stock at a later date.
Often a corporation will have a predetermined amount of capital that it desires to raise in a stock issue.
Stock subscriptions are taken to determine whether the corporation will meet its goal.
A subscription is a contract to purchase shares of stock at a certain price and describes the payment plan to pay for the shares.
Stockholder receives stock when payment is made.

40. A stock subscription gives the corporation a receivable from the subscriber and an obligation to hold enough stock for issue when the subscription is paid in full.
20--
May
Subscriptions Receivable—Common ,000.00
Common Stock Subscribed ,000.00
Subscription from Tyrone Coles to buy 400 shares of common stock at par value of $50 per share.
A stock subscription gives the corporation a receivable from the subscriber and an obligation to hold enough stock for issue when the subscription is paid in full.
The Subscriptions Receivable--Common is an asset reported in the Current Assets section of the balance sheet. The Common Stock Subscribed account will be reported in the Stockholders’ Equity section of the balance sheet.
The Common Stock Subscribed account appears in the Stockholder’s Equity section of the Balance Sheet. It will remain there until the stock is actually issued.

41. The stock is issued when full payment has been received for the subscription.
20--
June 1
Cash ,000.00
Subscriptions Receivable—Common ,000.00
Received Tyrone Coles’ subscription in full.
Common Stock Subscribed (400 shares) ,000.00
Common Stock (400 shares) ,000.00
Issued 400 shares of
common stock to Tyrone Cole. 1
When payment is received in full, the corporation will issue the shares. The first journal entry shows the receipt of cash and the subsequent journal entry shows the issuance of stock:
Dr. Cash, Cr. Subscriptions Receivable
Dr. Stock Subscribed-Common, Cr. Common Stock

42. Special Corporation Records and Agents
Objective 11
Describe the capital stock records for a corporation
Special Corporation Records and Agents
Corporations keep detailed records of stockholders’ equity and special corporate records such as:
Meeting minutes
Corporate bylaws
Stock certificate books
Stock ledgers
Stock transfer records
Corporations must keep detailed records of stockholders’ equity and special corporate records such as:
Meeting minutes
Corporate bylaws
Stock certificate books
Stock ledgers
Stock transfer records
A Minute Book--is the official diary of the corporation and the depository of official actions of the board of directors, kept by the corporate attorney or secretary. (Keeps the minutes” of the stockholder meetings.)

43. College Accounting, 12th Edition
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College Accounting, 12th Edition
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