U U N IT

7
Corporation

Overview

In unit 6, you were exposed to accounting for merchandizing operations to include

preparation of the financial statements for these types of organization. In unit 7 you
will examine what are corporations and discuss their characteristics and how they are
organized. The two components of stockholders’ equity, paid-in capital and retained
earnings will also be discussed in detail alongside dividends and stockholders’ rights.
The unit also describes the different classes of stock (common and preferred), their
characteristics, and entries for stock issuance. Also included is a discussion of issuing
common stock at par, at a premium, issuing no-par stock, issuing stock with a stated
value, issuing stock for assets other than cash, and issuing preferred stock. After a
discussion on the preparation of the stockholders’ equity section of a corporation
balance sheet, the unit continues with a discussion of closing entries affecting retained
earnings and is then concluded with a discussion on the accounting for cash dividends.

72  © 2015 University of the West Indies Open Campus

Learning Objectives

After reading the unit, and completing the learning activities, you will be able to:

1. Identify the distinguishing characteristics of a corporation.

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

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

4. Illustrate retained earning transactions.

5. Account for cash dividend.

This Unit comprises one session as follows:

Session 7.1: Corporations: Paid in Capital and the Balance Sheet

Readings & Resources

Required Reading
Horngren, C.T., Harrison, W.T., & Oliver, S.M. (2009). Accounting (8th ed.). Upper
Saddle River, NJ: Prentice Hall.

Suggested Reading
Accounting Principles: A Business Perspective. Retrieved from
https://dl.dropboxusercontent.com/u/31779972/Accounting%20
Principles%20Vol.%201.pdf

ACCT1002 Introduction to Financial Accounting – UNIT 7  73

 SSession 7.1

Corporations: Paid in Capital

and the Balance Sheet

Introduction
A corporation is a form of business entity incorporated by a group of shareholders
who have ownership of it. Although a corporation does not necessarily have to be for
profit, the vast majority of corporations are setup with the goal of providing a return
on the investment for its shareholders. Thus when you purchase stock you are part
owner in a corporation. An important aspect of a corporation is limited liability and
this allows the shareholders the right to participate in the profits through dividends
and/or the appreciation of stock, but are not held personally liable for the company’s
debts.

Horngren et al. 2009 (pp. 596-597) and the following video about Corporations: Types,
Advantages, Disadvantages and Examples found at: https://www.youtube.com/
watch?v=8IPsnGLhIIk discusses several features that distinguish a corporation from
other types of organizations to include the following:

1. Separate legal entity

2. Continuous life and transferability of ownership

3. No mutual agency

4. Limited liability of stockholders

5. Separation of ownership and management

6. Corporate taxation

7. Government regulation

74  ACCT1002 Introduction to Financial Accounting – UNIT 7

Classes of Stock
A corporation’s stocks can be classified into many different categories but the two
most fundamental categories of stock issued are common stock and preferred stock.
These stocks differ in the rights that they confer upon their owners.

Common Stock
If you own a share of common stock, then you are a partial owner of the company and
would be entitled to certain voting rights and privileges regarding company matters.
Typically, as a common stock shareholder, you are the last in line to receive the
company’s assets. This means that you would receive dividend payments only after
all preferred shareholders have received their dividend payments. In addition, if the
company goes bankrupt, as a common stock shareholder you will receive whatever
assets are left over only after all creditors, bondholders, and preferred shareholders
have been paid in full. Some companies have different “classes” of common stock that
varies based on how many votes are attached to them. For example, one share of Class
A stock in a certain company might give you two (2) votes per share, while another
share of Class B stock in the same company might only give you one (1) vote per share.

Preferred Stock
By owning a share of preferred stock you have partial ownership in a company, but
you may not enjoy any of the voting rights of common stockholders. As a preferred
stockholder, you are paid a fixed dividend that does not fluctuate once the company
decides to pay a dividend. The main benefit to owning preferred stock is that you have
a greater claim on the company’s assets than common stockholders. Consequently, as
a preferred shareholder you will always receive your dividends first and in the event
the company goes bankrupt, you are paid off before common stockholders.

LEARNING ACTIVITY 7.1

Common Stock
1. Explain or give reasons why a company might choose to issue two
different categories of common stock and use figures in a case type
situation to support your answer.

2. Post your response in the Student Tutor Exchange forum and

respond critically to at least one of your peers.

ACCT1002 Introduction to Financial Accounting – UNIT 7  75

 Why Does a Company Issue Stock?
A company at some point in time needs to raise money or capital to finance its operations.
In order to do so they can either borrow it from banks or lending institutions, issue
bonds or raise the funds needed by selling part of the company. Selling part of the
company, is known as issuing stock.

Horngren et al. (2009 p. 600) and the video at https://www.youtube.com/

watch?v=XSoRhuF7EY8 discusses the concepts of par value, stated value and no-par
stock which you ought to carefully note to aid your understanding of the areas to be
covered as we move forward.

Issuing Common Stock

You will appreciate based on what you have read thus far that common stock can
be issued either at par, at a premium or at no par. Typically, you would expect that
stocks are sold in exchange for cash as companies seek to raise funds to finance their
operations. However, this may not always be the case as stock can also be issued in
exchange for assets other than cash. You should note the following journal entries to
represent each of the cases mentioned:

1. Issuing common stock at par – Note here that this is computed by multiplying the
number of common stock issued by the par value of the stock.

Date Details DR CR
Cash XXX
Common stock XXX

2. Issuing common stock at a premium (above par) – Here you should note that the
entries are pretty much similar to the one above but a third account called a paid
in capital or otherwise called additional paid in capital (APIC) is credited with the
excess of the par value. For example if the par value was $10 and stock was sold
for $15, then the difference of $5 represents the paid in capital.

Date Details DR CR
Cash XXX
Common stock XX
Paid in capital in excess of par X

Horngren et al. (2009 p. 602) and the video found at https://www.youtube.com/

watch?v=XSoRhuF7EY8 illustrates the journal entries relating to issue of stock
at par and at a premium and also shows an extract of the equity section of the
company’s balance sheet which you should carefully note.

76  ACCT1002 Introduction to Financial Accounting – UNIT 7

3. Issuing stock at no par – Here you should note that in this scenario the company
merely records the stock at the price at which it is sold. Therefore the stock is
valued at the number of shares multiplied by the selling price and there is no
additional paid in capital involved.

Date Details DR CR
Cash XXX
Common stock XXX

Horngren et al. (2009 p. 603) illustrates the journal entries relating to the issue of one
million stocks on January 2 at no par. Here you should observe that the value of the
stock recorded was $20,000,000 (i.e. 1,000,000 *$20). You should note the differences in
the extract of the equity section of the company’s balance sheet in this case as opposed
to that mentioned earlier. As an alternative, you can refer to the video which illustrates
the journal entries associated with issuing of common stock at not par:

uuhttps://www.youtube.com/watch?v=XSoRhuF7EY8
4. Issue stock for assets other than cash – Here you should note that the asset received
in exchange for the stock is debited instead of cash as previously illustrated.

Date Details DR CR
Fixed assets (e.g. Building, furniture etc.) XXX
Common stock XX
Paid in capital in excess of par X

Horngren et al. (2009 p. 604) illustrates the journal entries relating to issue of stock in
exchange for a building. Note the computation of the amount recorded in the paid in
capital as this often presents a challenge to some students. You can learn more about
the issuance of common stock in exchange for other forms of assets on pages 534 to 535
at of your text book or use the link below to view the video entitled “Issue common
and preferred stock ch 13 p 2” for additional information:

uuhttps://www.youtube.com/watch?v=XSoRhuF7EY8

ACCT1002 Introduction to Financial Accounting – UNIT 7  77

 Issuing Preferred Stock
The journal entries to record the issuing of preferred stock are pretty much the same
as those to record common stock. The only difference is the preferred stock account is
credited instead of common stock.

1. Issuing preferred stock at par – note here that this is computed by multiplying the
number of preferred stock issued by the par value of the stock.

Date Details DR CR
Cash XXX
Preferred stock XXX

2. Issuing preferred stock at a premium (i.e. above par value).

Date Details DR CR
Cash XXX
Preferred stock XX
Paid in capital in excess of par X

Horngren et al. (2009 p. 604) illustrates the journal entries relating to the issue of
preferred stock at par and at a premium and also shows an extract of the equity section
of the company’s balance sheet which you should also carefully note on page 605. You
can learn more about the issue of preferred stock at par and at premium at:

uuhttps://www.youtube.com/watch?v=XSoRhuF7EY8
Before moving on to the Learning Activity 7.2, you should carefully note the summary
problem and solution, Horngren et al. (2009 pp. 607-608) provides some useful insights
to allow you to master this area.

78  ACCT1002 Introduction to Financial Accounting – UNIT 7

 LEARNING ACTIVITY 7.2
Preferred Stock
1. The charter of WPAC-TV authorizes the company to issue 100,000
shares of $3, no-par preferred stock and 500,000 shares of
common stock with $1 par value. During its start-up phase, the
company presented the following transaction and you are required
to prepare the necessary journal entries:

• August 6 – Issued 500 shares of common stock to the

promoters who organized the corporation, receiving cash of
$15,000:

• August 12 – issued 700 shares of preferred stock for cash of

$27,000; and

• August 14 – issued 1,600 shares of common stock in exchange

for land valued at $17,000.

2. Post your response in the Student Tutor Exchange forum and

respond critically to at least one of your peers.

Retained Earnings
You will recall as done in units 3 and 6 that we closed out expenses and income to
income summary and thereafter transferred the net income or loss to retained earnings.
Remember that the net income is the difference or excess of the income over the expenses
while the net loss is the opposite. Horngren et al (2009 p. 609) used two examples to
illustrate the journal entries associated with both scenarios. Here you should note that
in the case of net income the income summary is debited while the retained earnings
are credited. On the other hand, where there was a net loss the retained earnings was
debited $60,000 and the income summary credited $60,000. Note also on page 610,
where the extract of the company’s equity section of the balance sheet shows that the
loss recorded in retained earnings was subtracted to obtain the ending stockholder’s
equity balance. You should note that had the retained earnings been recorded as a
profit that this amount would have been added to obtain the ending stockholder’s
equity balance. As an alternative to the above, you can click on the following link and
watch the video about Stockholders Equity Transaction which illustrates the closing
out process of retained earnings:

uuhttps://www.youtube.com/watch?v=6jFR4f5SvBE

ACCT1002 Introduction to Financial Accounting – UNIT 7  79

 LEARNING ACTIVITY 7.3
Retained Earnings
1. As a follow up to Activity 7.2 you are you told that WPAC-TV closed
net income of $35,000 into retained earnings. You are now required
to record the journal entry relating to this transaction.

2. Post your response in the Student Tutor Exchange forum and

respond critically to at least one of your peers.

Accounting for Cash Dividends

Dividends are the distribution of cash from the profits of a corporation to its
shareholders. When the board of directors declares a cash dividend, you should debit
the Retained Earnings account and credit the Dividends Payable account. By making
this entry, you are effectively reducing equity and increasing liabilities. Thus, there is
an immediate decline in the equity section of the balance sheet as soon as the board of
directors declares a dividend, even though no cash has yet been paid out.

Date Details DR CR
Retained earnings X
Dividend payable X

When a dividend is eventually paid out, you must debit the Dividends Payable
account and credit the Cash account. By doing this, you are effectively reducing both
the cash and the offsetting liability. The net effect of these two transactions is to reduce
cash and equity, which means that the entire impact of the cash dividend is contained
within the balance sheet and there is no impact on the income statement.

Date Details DR CR
Dividend payable X
Cash X

Dividends can be stated as a percentage based on the nominal/par value of the share
or alternatively as an amount per share. For example a $0.08 dividend on a $1 stock
can be expressed either as 8% or $0.08 per stock. In the case of common stock you
would compute the dividend as follows:

80  ACCT1002 Introduction to Financial Accounting – UNIT 7

 Dividend payable = # of stock issued * $ value of dividend declared
(or the percentage declared as payable as dividend).

In the case of preferred stock, the dividend is often expressed as a percentage of the
preferred stock par value. To compute the dividend for the preferred stock holder you
can use the following:

Dividend payable on preferred stock = # of preferred stock issued * (par value * %)

Horngren et al. (2009 pp. 611-613) illustrates the various computations for the various
classes of stock and their respective journal entries which you should carefully note
before moving on to learning activity 7.4. The video link under the heading retained
earnings provides additional info on the computation of dividends.

LEARNING ACTIVITY 7.4

Computing Dividends
1. The following elements of stockholders’ equity are adapted from the
balance sheet of Smitts Marketing Corp.

Smitts Marketing Corp.

Stockholders’ Equity
Preferred stock, 8% cumulative, $2 par, 80,000 shares
authorized, issued and outstanding $160,000
Common stock, $0.10 par, 10,000,000 shares authorized,
9,250,000 shares, issued and outstanding $925,000

Smitts paid no preferred dividends in 2008.

You are required to compute the dividends to preferred and

common stock for 2009 if total dividends are $150,000.

2. Post your response in the Student Tutor Exchange forum and

respond critically to at least one of your peers.

ACCT1002 Introduction to Financial Accounting – UNIT 7  81

 Session and Unit 7 Summary
This unit introduced you to the distinguishing features of a corporation and the
various sources of stockholders’ equity. In addition, the various classes of stock and
the journal entries to record the issuance of them were discussed. The preparation
of the stockholders’ equity section of the balance sheet was emphasized and the
computation and journal entries related to cash dividend was discussed to conclude
the unit. Unit 8 the final unit, introduces you to the basic concepts and purposes of
the Statement of Cash Flows and also discusses operating, investing, and financing
activities.

82  ACCT1002 Introduction to Financial Accounting – UNIT 7

References
Horngren, C. T., Harrison, W. T., & Oliver, S. M. (2009) Accounting (8th ed.). Upper
Saddle River, NJ: Prentice Hall.

Accounting Principles: A Business Perspective. Retrieved from

https://dl.dropboxusercontent.com/u/31779972/Accounting%20
Principles%20Vol.%201.pdf

Features of corporation [Video file]. Retrieved from https://www.youtube.com/

watch?v=8IPsnGLhIIk

Issuing of stock [Video file]. Retrieved from https://www.youtube.com/

watch?v=XSoRhuF7EY8

Retained Earnings [Video file]. Retrieved from https://www.youtube.com/

watch?v=6jFR4f5SvBE

ACCT1002 Introduction to Financial Accounting – UNIT 7  83