CHAPTER 7

ACCOUNTING FOR CORPORATIONS

- Definition: A corporation is an association of individuals, created by law and having an

existence separate and distinct from that of its owners who are called stockholders. It may be
established as a profit making or nonprofit organization. For-profit-corporation may be
publicly or privately held. The stock of a public company is traded on a stock exchange.
There may be thousands, even millions, of stockholders in a public company. Stock of a
privately held (closely held) corporation is not traded on an exchange and there are usually
only a small number of stockholders.

Characteristics of a Corporation
- The most important characteristics of a corporation which have accounting implications are
discussed below
• A separate legal entity―Before the law a corporation is an artificial person having
many of the rights and obligations of a real person. It may acquire, own, and dispose of
property in its own name, enter into contracts, incur liabilities, pay taxes, may sue and
be sued. But it is not allowed to hold public office or vote.
• Easily transferable ownership rights― Ownership in a corporation is represented by
stock certificates, that is why the owners are called stockholders. These shares are
easily transferable in stock exchange markets without the approval of other
stockholders without affecting the existence of the corporation, unlike a partnership.
Once a public corporation sells its initial offering of stock, it is not part of any
subsequent transfers except as a record keeper of share ownership. Privately held
companies may have some restrictions on the transfer of stock.
• Limited liability― the liability of stockholders is limited to the amount each has
invested in the corporation. Personal assets of stockholders are not available to creditors
or lenders seeking payment of amounts owed by the corporation. Creditors are limited
to corporate assets for satisfaction of their claims. To many investors this is the most
important advantage of a corporate form.
• Separation of ownership from Mg-- Investors in a corporation need not actively manage
the business, as most corporations hire professional managers to operate the business.
The investors vote on the Board of Directors who are responsible for hiring
management.
• Taxable entity― Corporate income is taxed; and when income is distributed to
shareholders as dividends, it is taxed a second time. Thus there is double taxation.
• Government regulations― The sale of stock results in government regulation to protect
stockholders, the owners of the corporation. For example, publicly held companies with
stock traded on exchanges markets are required to file their financial statements and
additional informative disclosures with the Securities and Exchange Commission.

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 Advantages of a Corporation
• Limited liability— there is no personal liability for stockholders
• Ease of capital accumulation― the easy transfer of ownership and the limited liability
of stockholders are attractive features to potential investors makes it easier for a
corporation to raise large amounts of capital.
• Continuous life― perpetual life is possible for a successful corporation because as a
separate legal entity change in ownership doesn’t affect the life of a corporation.
• Easy transfer of ownership― because shares are freely and frequently transferred, it is
necessary for the corporation to revise the subsidiary ledger of stockholders
periodically, generally in advance of every dividend payment or stockholders’ meeting.
• Management specialization― in a corporation owners do not have direct involvement
in the management. People with the necessary expertise are entrusted the responsibility
to manage the company.
• Separation of owners and entity— since the corporation is considered a separate legal
entity, the owners do not have the power to bind the corporation to business contracts.
There is not mutual agency

Disadvantages of a Corporation
• Double taxation― The Corporation pays tax on its income, and stockholders pay a tax
on corporate income received as dividend.
• Separation of ownership from management― Though it may be an advantage in many
cases in a few instances a management group may choose to operate a corporation from
the benefit of insiders not stockholders bringing a conflict of interest.
• Legal constraints― because corporations are created by law, they are subject to greater
regulation and control than a sole proprietor and partnership.
• Limited ability to raise creditors’ capital― the limited liability nature of a corporation
may make creditors reluctant to lend corporations money beyond a certain level without
the personal guarantee of a stockholder or officer of the corporation.

Organizing a Corporation:
- To form a corporation one or more incorporators submit an application to the corporation
commissioner or other designated officials of a state government. The application identifies
the incorporators, states the nature of the business, and describes the capital stock to be
issued.
- After payment of an incorporation fee and approval of the application, articles of
incorporation are approved by the state as evidence of the legal existence of the corporation.
The incorporators, elect board of directors and approve bylaws to serve as a general guideline
for the operation of the corporation.
- A corporation’s charter (also called Articles of Incorporation) must include the following
information:
• Authorized number and types of shares to be issued, including their rights,
restrictions, and privileges.
• Company name: must include "limited," "incorporated," or "corporation"
• Location of the company's registered office.

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- Each state has its own business incorporation act, and the accounting for stockholder’s equity
follows the provision of this act.

Organization Costs
- The formation of a corporation is a much more costly than the organization of a partnership
and a sole proprietorship
- The necessary costs incurred during formation of a corporation included: legal fees,
incorporation fees, underwriters' fees for stock, taxes and fees paid to the state and
promotional costs.
- These costs are necessary to bring the corporation into existence and are charged to an
intangible asset called organization costs. Organization costs are amortized over any
reasonable period of not more than 40 years. They are usually small and not material;
therefore there may be support for a short amortization period.

Example: A corporation paid state incorporation fees and attorney’s fees of $35,000 to
complete the incorporation process. These costs are recorded as follows:
Organization costs ………………………….. 35,000
Cash …………………………………… 35,000
Assuming the corporation amortizes the organization cost over 25 year, we will
have a yearly amortization expense of recorded as follows:
Amortization expense ……………………. 1400
Organization costs ………………….. 1400

Rights to Shareholders
- In the absence of restrictive provision, in the articles of incorporation, stock certificates, and
the provision of the state law , each share carries the following rights:
• Voting right—shareholders participate in management indirectly by voting at
the stockholders’ meeting. They vote on questions as: mergers and acquisitions, the
selection of independent auditors, the incurring of long-term debts, changing the charter,
election of BOD and other related issues
• Dividend rights—to share in profits by receiving dividends declared by the
BOD
• Preemptive rights—refer to the right of priority to purchase additional shares
sold by the corporation. This allows stockholders to maintain their percentage of
ownership in a corporation when additional shares are issued.
• The right to receive assets upon liquidation in proportion to the number of
shares owned.

Corporate Financial Statements:

Income Statement:
- Very similar to those of unincorporated businesses.
- Income tax expense occurs in a corporation as corporations are required to pay tax because
they are a separate legal entity.
- Net income in a corporation means income after tax.

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 Statement of Retained Earnings
- Statement of Retained Earnings measures changes in retained earnings over a specific
period of time.
- Retained earnings is the amount of net income a corporation has earned since it began
business that has not been distributed as dividends to its stockholders. Net income increases
retained earnings. Dividends, net losses, and some treasury stock transactions decrease
retained earnings. Net income and dividends are transferred to retained earnings during the
closing entry process.
- Dividend is a distribution by a corporation to its owners in the form of cash, assets, or the
company's stock. Stockholders do not have withdrawal accounts like sole proprietors or
partners because the only way they can get money from the corporation is if the Board of
Directors authorizes a dividend.
- Information about owners’ (shareholders’) investments is not included on this statement.

Balance Sheet:
- Balance sheets for incorporated and unincorporated business are identical except for the
equity section. The focus of this chapter is entirely on this section.
- The equity section of a corporation is called shareholders’ equity or stockholders’ equity.
- The two main sources of stockholders' equity are:
1. Paid-in capital or contributed capital— capital contributed (investment) by the
stockholders. This section is further divided into:
• Capital stock(Common stock or preferred stock)—it is the legal capital
• Additional paid-in capital (Paid-In Capital in Excess of Par/Stated value)
2. Retained earnings— net income retained in the business.
- The SHE is subdivided to help stockholders and creditors know whether a corporation that
pays dividends is distributing earnings or is returning invested capital. Remember that
owners of a sole proprietorship and partnership may withdraw capital in any amounts they
choose, even through such withdrawals may exceed earnings. In a corporation, however,
only the retained earnings ordinarily are available for dividends. The classification of paid
-in capital as capital stock and additional paid-in capital (to be discussed later) is more of a
legal than an accounting requirement.

Paid-in capital
- The main source of paid-in capital is from issuing stock.
- The two primary classes of stock are common stock and preferred stock.
• Common Stock—has the four basic rights previously mentioned. It represents the
basic ownership interest. It is the residual corporate interest that bears the ultimate
risks of loss and receives the benefits of success. It is guaranteed neither dividends
nor assets upon dissolution. But common stockholders generally control the
management of the corporation and tend to profit most if the company is successful.
In the event that a corporation has only one authorized issue of capital stock, that
issue is by definition common stock, whether designated in the charter or not.

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• Preferred Stock- This class of stock usually carries certain benefits not available to
common stockholders. They generally receive dividends before common
stockholders. But the dividend is usually fixed which may be stated as an amount per
share or a percentage of par value. In the event the corporation is liquidated, they
have the right to receive assets before common stockholders. In return for any special
preference, the preferred stockholder is always to sacrifice some of the inherent rights
of capital stock interest such as the right to vote or the right to share in profits beyond
the stated rate. Motivation to issue preferred stocks include:
 To raise capital without sacrificing control of the corporation.
 To boost the return earned by common shareholders.
Preferred stock can be of two types: cumulative or noncumulative. Both are further
classified as participating and nonparticipating.
• Cumulative preferred stock— has a right to be paid both current and all prior
periods' unpaid dividends before any dividend is paid to common shareholders. These
unpaid dividends are referred to as “dividends in arrears”. Dividends are not
considered a liability until directors declare a dividend. So preferred dividends in
arrears are not considered to be a liability, but must be disclosed, usually in a note.
• Noncmulative preferred stock— the right to receive dividends expires if the
dividend is not declared. As a result they are not attractive to investors and rarely are
issued.
• Participating preferred stocks— Gives its owners the right to share in dividends in
excess of the stated percentage or amount.
• Nonparticipating preferred stock— Dividends are limited each year to a maximum
amount which is either a percentage par value or a specified amount.

Example:
Dividend per year to preferred stocks is Br 10,000
Dividend per year to common stocks is any remaining amount
No dividend was declared in year 1 and year 2
Dividend declared in year 3 was Br 25,000
Compute dividend for each class of stock and dividend in arrear(DA) in each year

If preferred stock is cumulative

Year 1 Year 2 Year 3
Preferred stock 10,000 (DA) 20,000 (DA) 5,000 (DA)
Common stock 0 0 0
Preferred stockholders receive Br 25,000 at end of year 3 with remaining dividend in
arrear of Br 5,000. Common stockholders receive nothing until dividend claim (including
dividends in arrears) by preferred stockholders are stratified.

If preferred stock is noncumulative and nonparticipating

Year 1 Year 2 Year 3
Preferred stock 0 0 10,000

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 Common stock 0 0 15,000
If preferred stock is noncumulative and participating (remaining amount in excess of Br
14,000 is to be divided between preferred and common stockholders in a 1 : 3 ratio
respectively.
Year 1 Year 2 Year 3
Pref. st. Com. St. Pref. st. Com. St. Pref. sto. Com. St.
Regular dividend 0 0 0 0 10,000 14,000
Remainder (1: 3) 0 0 0 0 250 750

- Preferred stock is normally nonparticipating

Par value and No par Value Stocks

- Both common stocks and preferred stocks can be par value shares or no par value shares.
 Par value― an arbitrary value assigned in a corporation's articles of incorporation to
one share of stock. It is printed on the stock certificate. In some states, the par value of
all outstanding shares is considered the legal capital of a corporation. Legal capital is
the amount of contributed capital that must remain in the corporation and may not be
paid out in dividends. Par value may be regarded as a minimum cushion of capital
existing for the protection of creditors. The par value of a stock has no relationship to
its fair market value. At present, the par value associated with most capital stock issues
is very low. Low par values help companies avoid contingent liability associated with
stock sold below par.
 No-par value stock— Laws permit the issuance of shares of stock that do not include a
par value. Two reasons to issue no-par stocks:
 To avoid the contingent liability that might occur if par value stock were
issued at a discount. No discount on capital stock is permitted by most states
 To avoid confusion as the use of par value may confuse some investors
because the par value doesn’t usually conform to market value
The Board of Directors may assign an arbitrary value to this type of stock which is
called Stated value. From an accounting view point, stated value and par value mean
the same thing – both terms designate the legal capital per share. The only difference is
stated value is not printed on the stock certificate.

Issuance of Stocks
- Authorized stock― it is the maximum number of shares that the corporation can issue
(sell) as designated in its charter (articles of incorporation). This gives a legal opportunity
to obtain assets through the sale of stock. With the approval of the stockholders the
corporation would have to apply to the government for permission to increase the number
of authorized shares. The authorization to issue stock is not a transaction. Rather it should
be disclosed.
- Issued Stocks― the number of shares transferred to stockholders in exchange for cash,
assets, or services rendered.
- Unissued stocks— stocks authorized but not yet issued. They are held for future issuance
when additional funds are needed. No right or privileges attach to these shares until they
are issued.

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 Authorized shares = Issued stock + Unissued stocks
- Outstanding stock― Issued stock that is held by stockholders and has not been bought
back by the corporation. They represent 100% of ownership of the corporation. The
number of stocks owned by an individual investor determines the extent of his or her
ownership of the corporation. The holders of these stocks are entitled to voting rights,
dividend rights and other rights.
- Treasury stock― Issued stock that has been bought back by the corporation.
Issued Stocks = Treasury Stocks + Outstanding stocks

Treasury stocks and unissued stocks are similar in that both are held within the
corporation, both may be issued in the future, both have no voting, dividend and other
rights. But they are different in that treasury stocks were sold but reacquired currently
whereas, unissued stocks were not issued and are held by the corporation. Treasury
stocks are reported in the balance sheet but unissued stocks are not reported.

So all outstanding stocks are issued stocks but the reverse is not necessarily true.

Recording Issuance of Stocks

- We follow the same basic rules to record both Common and Preferred Stock transactions.
Note that issuance of shares affects only contributed capital accounts, not retained earnings
accounts.
1. Shares issued at par for cash
- When par value stock is issued, the Capital Stock (common or preferred) account is
credited for an amount equal to par value times the number of shares issued.
Example: When ABC corporation issued 5,000 shares of its $2 par value common stock
at par for cash, they will record it as follows:
Cash ……………………………………… 10, 000
Common stock………………………. 10,000

- The capital stock accounts (preferred or common stock) are controlling accounts.
Individual stockholders accounts are kept in a subsidiary ledger known as the stockholders
ledger. It shows each stockholder’s name, address, number of shares held in order to issue
dividend checks, proxy forms etc

2. Issuance of shares above par

- When a corporation issues stock at more than par, Paid-In Capital in Excess of Par is
credited for the difference between the cash received and the par of the stock. The capital
stock account (common or preferred stock) is credited with the par value of the shares
issued, regardless of whether the issuance price is more or less than par value.
Example: If ABC Corporation sold their $2 par value of common stock for $5 per share,
they would record it as follows:
Cash ………………………………………… 25,000
Common stock …………………………. 10,000
PIC in excess of par ……………………. 15,000

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- The excess amount received doesn’t represent a profit to the corporation. It is a part of the
investment of the stockholders and is therefore part of the paid-in capital. An equity
account called Additional Contributed Capital is used for any premiums.
- PIC in excess of par is distinguished from the capital stock account because usually it is not
a part of the legal capital and in many states may be used as a basis for dividends to
stockholders. However, if the premium is returned to stockholders as dividend at a later
date, the dividend is a return of paid-in capital, called liquidating dividend, rather than a
distribution of earnings.
3. Issuance of shares below par value
- Most states do not permit the issuance of stock at a discount. In others, it may be done only
under certain conditions. When stock is issued at less than its par, it is considered to be
fully paid as between the corporation and the stockholder. In some states, however, the
stockholders are contingently liable to creditors for the amount of the discount. When
capital stock is issued at a discount, a discount account is debited for the amount of the
discount. The discount on capital sock is deducted from the par amount of capital stock in
the paid-in capital section of the SHE. Since issuing stock at a discount is rare, it is not
illustrated here.

4. Issuance of shares for noncash conditions.

- Stocks may be used to acquire assets (eg. Land, equipment), to pay expenses or to settle
liabilities. A value must be assigned using the cost principle which requires that the
noncash condition should be recorded at:
 The fair market price of the stock issued or
 The fair market price of the asset received whichever is more clearly evident
- If the total value exceeds the par or stated value of the stock issued, the value in excess of
the par or stated value is added to the additional paid-in-capital (or paid-in-capital in excess
of par) account.
Example: Assume ABC Co. issued 4,000 of its $2 par value common stocks in
exchange for equipment with a fair market value of $36,000.
Equipment …………………………. 36,000
Common stock ……………….. 8,000
PIC in excess of par ………… 28,000
To record issuance of shares in exchange for equipment

5. Issuance of no-par shares

- When no-par stock is issued, the Capital Stock (common or preferred) account is credited
for an amount equal to the value of the consideration received even though the issuance
price varies from time to time.

Example: If HH Corporation issues 4,000 shares of no-par stock at $6 a share and at a

later dates issues 1,000 additional shares at Br 10, the entries would be as follows:
Cash ……………………………………… 24,000
Common stock ………………………… 24,000

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 Sale of 4,000 shares of stock at $6 per share
Cash ……………………………………… 10,000
Common stock ………………………… 10,000
Sale of 1,000 shares of stock at $10 per share

- The laws of some states require that the entire proceeds from the issuance of no-par stock
be regarded as legal capital. The preceding entries conform to this principle.
- In other states, no-par stock may be assigned a stated value by the BOD, but may be
accounted for in the same way as true no-par stock. Alternatively, the stated value may be
considered similar to par value with any excess above stated value being accounted for as
additional paid-in capital.

Example: Assuming that in the previous example for HH Co. the stated value is $2 and
the BOD wishes to credit the common stock for stated value, the transactions would be
record as follows:
Cash ……………………………………… 24,000
Common stock ………………………… 8,000
PIC in excess of stated value ………… 16,000
Sale of 4,000 shares of no-par stock, stated value $2 at $6 per share

Cash ……………………………………… 10,000

Common stock ………………………… 2,000
PIC in excess of stated value ………… 8,000
Sale of 1,000 shares of no-par stock, stated value $2, at $10 per share
- If a corporation has both par value and no-par value common stock, separate common stock
accounts must be maintained.
6. Issuance of shares via subscription
- Stock is often issued through subscriptions. A subscription is a contract (agreement) to
acquire shares of stock, with payments to be made at a future date or in a series of
installments. It is similar to the installment sales. The agreement is made between the
subscriber (the person contracting to acquire the shares) and the board of directors.
Entries:
• When the contract is signed Stock subscription receivable account and cash
(for any down payment are debited and stock subscribed is credited at par and
any excess is credited to PIC in excess of par/stated value.
Example: KK Corporation received subscription to 2,500 shares of preferred
stock with a par value of $12 at a price of $20, collecting 15% of the subscription
price. The entry is as follows:
Subscription receivable-preferred ……………. 42,500
Cash ………….………………………………… 7,500
Preferred stock subscribed ………………… 30,000
PIC in excess of par-pref. stock …………... 20,000

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 Note that stock subscription receivable is an asset (current asset). Stock
subscribed is a temporary capital stock account.
• When cash is collected from the subscribers, it is recorded by debiting cash
and crediting subscription receivable.
Example: KK Co. received 50% of the subscription price. The entry is as
follows:
Cash ……………………………………………. 25,000
Stock sub. receivable …………………..….. 25,000
• When the subscription price has been fully collected, the stock certificate will
be issued. The final collection of cash is recorded as usual but the temporary
account, stock subscribed, will be replaced by the capital stock account
(common or preferred).
Example: KK Co. received the subscription in full and issued the certificate.

Cash ………………………………. 17,500

Stock sub. receivable ……….... 17,500
To record the collection of the remaining price

Preferred Stock subscribed …………… 30,000

Capital stock (Preferred stock) ……. 30,000
To record the issuance of the stock certificate
- Note that stock certificates are not issued until a subscriber has paid in full. So the stock
subscribed account is used to show the amount of stock subscribed but not yet issued.
When collections are made in full, certificates are issued and the stock subscribed account
is closed to capital stock account.

Treasury Stock
- Treasury stock is the corporation's issued stock that has been reacquired back from the
stockholders.
- Treasury stock is a corporation’s own stock that:
(a) was outstanding,
(b) has been reacquired by the corporation, and
(c) is not retired.
- As a corporation cannot be its own shareholder, any shares reacquired by the corporation
are not considered assets of the corporation.
- Assuming the corporation plans to re-issue the shares in the future (i.e, the shares have not
been canceled), the shares are held in treasury and reported as a reduction in stockholders'
equity in the balance sheet after retained earnings.
- Treasury stock is essentially the same as unissued stock. Shares of treasury stock do not
have the right to vote, receive dividends, or receive a liquidation value.

Ways of Reacquisition
1. Purchase
- Although there are some legal restrictions on the practice, a corporation may reacquire its
share through purchase from the market. The reasons for reacquisition are:

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  if shares are needed for employee compensation plans, or to resale to employees
 for speculative purposes-to reissue the stock later at a higher price
 to stimulate trading, and without changing net income, to increase EPS.
Earnings per share = Net income available for common stockholders
Number of outstanding common stocks
2. In payment of debt owed by a stockholder
3. Donation—employees or stockholders may give back shares to
corporations
Journal Entries
- The most widely used method, the cost method, will be used in our discussion.

1. Purchase of Shares for Cash

- Under the cost method of accounting the account Treasury stock is debited for the price
paid to reacquire it. The par and the price at which the stock was originally sold (issued)
are ignored. Because the treasury stock account is a contra account to the other
stockholders' equity accounts, it has a debit balance.
Example: LL Corporation repurchases 15,000 shares of its $1 par value common stock
previously issued at $20 per share for $25 per share. The entry looks like the following:
Treasury stock ……………………….. 375,000
Cash …………………………………. 375,000
To record the repurchase of 15,000 shares at $25
- Treasury shares are included in the number reported for shares issued but are subtracted
from issued shares to determine the number of outstanding shares.
2. Donation – no journal entry is made since donated treasury shares have no cost, only a
memorandum entry is required. For example, if stockholders of LL corporation donate to
a corporation 3,000 shares it is recorded as follows:
Memo. The company received 3,000 shares of its own common stock via donation

But when they are reissued the only entry required is a debit to cash and a credit to PIC

3. Sale of Treasury Stock

- When treasury stock is sold, the accounts used to record the sale depend on whether the
treasury stock was sold above or below the cost paid to purchase it.
Treasury Stock sold above its Cost
- The sale increases (debits) cash for the proceeds received, decreases (credits) treasury stock
for the cost paid when the treasury stock was repurchased, and increases (credits)
additional paid-in-capital—treasury stock for the difference between the selling price and
the repurchase price.
Example: LL Corporation subsequently sells 7,500 of the shares repurchased for $25 for
$28, the entry to record the sale would be as follows:

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 Cash (7,500 × $28) …………………………… 210,000
Treasury Stock (7,500 × $25) ………….. 187,500
Additional paid-in-capital (treasury stock) … 22,500
Record sale of 7,500 shares of treasury stock at $28
- Note that as treasury stocks are not assets, we do not record gain or loss. Rather we debit or
credit paid in capital –treasury stock.
- Paid-in capital from sale of treasury stock is reported in the paid-in capital section of the
balance sheet.
Treasury Stock sold below its Cost
- When the reissue is less than acquisition price (cost), the excess of cost over the selling
price is debited to any paid-in capital from previous treasury stock transactions, if the
account has a balance for the difference. If the balance in additional PIC- treasury stock is
insufficient, the remaining difference is charged to retained earnings after the additional paid-
in-capita—treasury stock account balance is reduced to zero. By definition, no paid-in
capital account can have a debit balance. Note also that any beginning balance in additional
paid-in-capital—treasury stock account should also be considered.

Example: If LL Corporation sells the remaining 7,500 shares of its treasury stock for
$21, the entry to record the sale would be as follows:
Cash (7,500 × $21) …………………………… 157,500
Additional paid-in-capital (treasury stock) …… 22,500
Retained Earnings …………………………….. 7,500
Treasury Stock (7,500 × $25) ………….. 187,500
Record sale of 7,500 shares of treasury stock at $21
4. Sale of Donated Shares
Example: If LL sells 3000 of the donated shares for $20 per share, the journal entry
will be as follows:
Cash ……………………….. 60,000
PIC- donation or
Donated capital …………. 60,000

The Balance Sheet: Stockholders' Equity

- Preferred stock, common stock, additional paid-in-capital, retained earnings, and treasury
stock are all reported on the balance sheet in the stockholders' equity section. Information
regarding the par value, authorized shares, issued shares, and outstanding shares must be
disclosed for each type of stock. If a company has preferred stock, it is listed first in the
stockholders' equity section due to its preference in dividends and during liquidation.
- The partial balance sheet of ABC Corporation as of December 31, year 5 with assumed
figures is as follows:

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 Paid-in Capital:
Preferred, 8% stock, $50 par (100,000 shares
authorized, 23,000 shares issued) ……………………………… $1,150,000
Preferred stock subscribed, $50 par (4,000 shares) ……………. 200,000
PIC in excess of par- Pref. stock ………………………………. 84,000 $1,434,000
Common stock, $25 par(500,000 shares authorized,
140,000 shares issued, and 139,000 shares outstanding) ………. $3,500,000
PIC-in excess of par- Common stock ………………………….. 680,000 4,180,000
Additional PIC-Treasury stock ………………………………….. 1,000
Total paid-in capital ……………………………………….. $5,615,000
Retained earnings ……………………………………………… 3,580,000
Total ………………………………………………………… $9,195,000
Deduct treasury common stock (1000 shares at cost) …………. 26,000
Total stockholders’ equity ……………………………………… $9,169,000

Equity per Share (Book value per share)

- Several ratios use stockholders’ equity related amounts to evaluate a company’s profitability
and long-term solvency. One of these ratios is equity per share (EPS) also called book
value per share.
- When there is only one class of stock (i.e, common stock), EPS is calculated by dividing
stockholders’ equity by the number of shares outstanding (plus common shares subscribed
but not yet issued, if any)

EPS = Total Stockholders’ Equity

# of shares outstanding

- If a corporation has both preferred and common stock, it is necessary first to allocate the
total SHE between the two classes.
In making the allocation, preferred stocks have preferential rights to get:
i) The specified liquidation value per share. i.e., the right to receive assets
upon liquidation before common stock
ii) Cumulative dividends in arrears

- The remaining SHE is given to common stockholders. This reflects the fact that common
stockholders are the residual owners of the corporate entity.

After the allocation, the EPS of each class may then be determined as follows:

EPS Common stock = Shareholder’s Equity Applicable to Common Shares

# of common shares outstanding

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 EPS Preferred stock = Shareholder’s Equity Applicable to Preferred Shares
# of preferred shares outstanding

Example 1: The SHE section is given below:

Common stock $10 par, 100,000 shares authorized,
Issued and outstanding ………………………… $1,000,000
PIC- in excess of par-Common stock ………………………… 400,000
Deficit ……………………………………………………….. 130,000
Required: Compute EPS
Solution:
Total SHE = PIC + RE
= $1,000,000 + $400,000 - 130,000
= $1,270,000
EPS = $1,270,000 = $12.70 per share
100,000 shares
Example 2: Your are given the following end of year 2 information:
Preferred 10% stock, $50 par …………………………….. $500,000
Common stock, $20 par ………………………………….. 4,000,000
PIC in excess of par – Preferred ………………………….. 250,000
PIC in excess of par –Common ………………………….. 1,200,000
Retained Earnings ………………………………………… 660,000
Preferred stock has prior claim to assets on liquidation to the extent of 110% of par.
Dividends on preferred stock are in arrears for 2 years, including the dividend of the
current year
Required: Compute EPS for common stock and preferred stock
Solution
Total SHE …………………………………………………….. $6,610,000
Allocation to preferred stock(10,000 shares):
Liquidation value(110% x $50 x 10,000 shares) … 550,000
Dividends in arrears(10% x $500,000) x 2 years … 100,000 650,000
Allocated to Common Stock(the remainder) …………………….. $5,960,000
EPS Preferred stock = $650,000 = $65 per share
10,000 shares
EPS Common stock = $5,960,000 = $29.8 per share
200,000 shares
- EPS, particularly of common stock, is often stated in corporation reports to stockholders
and quoted in the financial press. It is one of the many factors affecting the market price,
that is, the price at which a share is bought and sold at a particular moment. However, it
should be noted that earning capacity, dividend rates, and prospects for the future usually
affect the market price of listed stocks to a much greater extent than does equity per share.

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- EPS does not indicate the amount which the holder of a share of stock would receive if the
corporation were to be dissolved. In liquidation, the assets would probably be sold at a
price quite different from their carrying values in the accounts and the SHE would go up or
down accordingly.

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