Professional Documents
Culture Documents
Financial Accounting, 4e
Financial Accounting, 4e
Prepared by
Gregory K. Lowry
Mercer University
Marianne Bradford
The University of Tennessee
Corporate Stockholders’
Organization and Dividends Retained Earnings Equity Presentation
Stock Transactions and Analysis
Characteristics
Cash dividends
Retained earnings Presentation
restrictions
Forming a Stock dividends Analysis
corporation
Prior period
Stock splits
adjustments
Corporate capital
Retained earnings
Common stock
statement
issues
Treasury stock
Preferred stock
THE CORPORATE FORM
OF ORGANIZATION
Two common bases that are used to classify
corporations are by purpose and ownership.
A corporation may be organized for the purpose of
making a profit, or it may be nonprofit.
Classification by ownership distinguishes between
publicly held and privately held corporations.
1 A publicly held corporation may have thousands of
stockholders and its stock is traded regularly on a
national securities market.
2 A privately held corporation (or closely held
corporation) usually has only a few stockholders
and does not offer its stock for sale to the general
public.
CHARACTERISTICS OF
A CORPORATION
A number of characteristics distinguish a corporation
from proprietorships and partnerships.
The most important of these characteristics are:
1 Separate legal existence – As an entity separate and
distinct from its owners, the corporation acts under its
own name rather than in the name of its stockholders.
2 Limited liability of stockholders – Since a corporation
is a separate legal entity, creditors ordinarily have
recourse only to corporate assets to satisfy their
claims.
3 Transferable ownership rights – Ownership of a
corporation is shown in shares of capital stock, which
are transferable units.
CHARACTERISTICS OF
A CORPORATION
4 Ability to acquire capital – It is relatively easy for a
corporation to obtain capital through the issuance
of stock.
5 Continuous life – The life of a corporation is stated in its
charter; it may be perpetual or it may be limited to a
specific number of years.
6 Corporate management – Although stockholders legally
own the corporation, they manage the corporation
indirectly through a board of directors they elect.
7 Government regulations – A corporation is subject to
numerous state and federal regulations.
8 Additional taxes – Corporations, unlike proprietorships
and partnerships, must pay federal and state income
taxes as a separate legal entity.
ILLUSTRATION 12-1
CORPORATION ORGANIZATION CHART
The president is the The controller’s
chief executive officer responsibilities include
Stockholders
(CEO) with direct 1 maintaining the
responsibility for accounting records
managing the business. 2 maintaining adequate
The chief accounting internal control system
Board of
officer is the controller. 3 preparing financial
statements, tax returns Directors
and internal reports.
President
Treasurer Controller
ILLUSTRATION 12-2
ADVANTAGES AND DISADVANTAGES
OF A CORPORATION
Advantages Disadvantages
Separate legal existence Corporation management – separation of Limited ownership
ownership and management Transferable ownership rights Government regulations
Ability to acquire capital Additional taxes Continuous life Corporation management –
professional
managers
FORMING A CORPORATION
1,000
1,000
ACCOUNTING FOR
COMMON STOCK ISSUES
5,000
1,000
4,000
ILLUSTRATION 12-6
STOCKHOLDERS’ EQUITY – PAID-IN
CAPITAL IN EXCESS OF PAR VALUE
The total paid-in capital from these two
transactions is $6,000, and the legal capital is
$2,000. If Hydro-Slide, Inc. has retained earnings
of $27,000, the stockholders’ equity section is as
follows:
Stockholders’ equity
Paid-in capital
Common stock $
2,000
Paid-in capital in excess of par value 4,000
40,000
25,000
15,000
ACCOUNTING FOR
COMMON STOCK ISSUES
Paid-in Capital in Excess of Stated Value is reported
as part of paid-in capital in the stockholders’ equity
section. When no-par stock does not have a stated
value, the entire proceeds from the issue become legal
capital and are credited to Common Stock. If
Hydro-Slide does not assign a stated value to its no-par
stock, the issuance of the 5,000 shares at $8 per share
for cash is recorded as follows:
40,000
40,000
ACCOUNTING FOR
COMMON STOCK ISSUES
Stock may be issued for services or for
noncash assets.
A question arises in such cases as to the cost
that should be recognized in the exchange
transaction.
To comply with the cost principle in a noncash
transaction, cost is the cash equivalent price.
Thus, cost is either the fair market value of the
consideration given up or the fair market
value of the consideration received, whichever
is more clearly determinable.
ACCOUNTING FOR
COMMON STOCK ISSUES
The attorneys for The Jordan Company agrees to accept 4,000
shares of $1 par value common stock in payment of their bill of
$5,000 for services performed in helping the company to
incorporate. There is no established market price for the stock at
the time of the exchange. Since the market value of the
consideration received, $5,000 is more clearly evident, the
appropriate entry is:
5,000
4,000
1,000
ACCOUNTING FOR
COMMON STOCK ISSUES
Athletic Research Inc. is a publicly held corporation whose $5 par
value stock is actively traded at $8 per share. The company issues
10,000 shares of stock to acquire land recently advertised for sale at
$90,000. On the basis of these facts the market price of the
consideration given is the most clearly evident value. The par or
stated value of the stock is never a factor in determining the cost of the
assets received. The entry is:
80,000
50,000
30,000
ACCOUNTING FOR
TREASURY STOCK
Treasury stock is a corporation’s own stock that has been
issued, fully paid for, and reacquired by the corporation but
not retired.
A corporation may acquire treasury stock for the reasons
listed below.
1 Reissue the shares to officers and employees under bonus
and stock compensation plans.
2 Increase trading of the company’s stock in the securities
market in the hopes of enhancing its market value.
3 Have additional shares available for use in the
acquisition of other companies.
4 Reduce the number of shares outstanding and thereby
increase earnings per share.
5 Rid the company of disgruntled investors, perhaps to
avoid a takeover.
ILLUSTRATION 12-7
STOCKHOLDERS’
EQUITY WITH NO TREASURY
STOCK
The cost method is normally used in accounting for treasury stock.
Under the cost method, Treasury Stock is debited at the price paid to
reacquire the shares, and the same amount is credited to Treasury
Stock when the shares are sold. On January 1, 2002, the
stockholders’ equity section of Mead, Inc. has 100,000 shares of $5
par value common stock outstanding (all issued at par value) and
Retained Earnings of $200,000.
Stockholders’ equity
Paid-in capital
32,000
32,000
ILLUSTRATION 12-8
STOCKHOLDERS’
EQUITY WITH TREASURY
STOCK
Treasury Stock is deducted from total paid-in capital and retained
earnings in the stockholders’ equity section. Both the number of shares
issued (100,000) and the number of shares in the treasury (4,000) are
disclosed. The difference is the number of shares of outstanding stock
(96,000). The term outstanding stock means the number of shares of
issued stock that are being held by stockholders. The stockholders’
equity section of Mead, Inc., after purchase of treasury stock, is as
follows:
Stockholders’ equity
Paid-in capital
10,000
8,000
2,000
ACCOUNTING FOR
TREASURY STOCK
The $2,000 credit in the July 1 entry is not made to
Gain on Sale of Treasury Stock for two reasons:
1 Gains on sales occur when assets are sold and
treasury stock is not an asset.
2 A corporation does not realize a gain or suffer a loss
from stock transactions with its own stockholders.
Paid-in capital arising from the sale of treasury stock
should therefore not be included in the measurement
of net income.
Paid-in Capital from Treasury Stock is listed
separately on the balance sheet as part of paid-in
capital.
ACCOUNTING FOR
TREASURY STOCK
When treasury stock is sold below its cost, the excess of cost
over selling price is usually debited to Paid-in Capital from
Treasury Stock. If Mead, Inc. sells an additional 800 shares
of treasury stock on October 1 at $7 per share, the entry is:
5,600
800
6,400
ILLUSTRATION 12-9
TREASURY STOCK ACCOUNTS
15,400
1,200
1,000
17,600
PREFERRED STOCK
120,000
100,000
20,000
ILLUSTRATION 12-10
COMPUTATION OF TOTAL DIVIDENDS
TO PREFERRED STOCK
Preferred stockholders have the right to share in the distribution of corporate
income before common stockholders.
Preferred stock contracts often contain a cumulative dividend feature – which
means that preferred stockholders must be paid both current-year dividends and
any unpaid prior-year dividends before common stockholders receive dividends.
Cumulative preferred dividends not declared in a given period are called
dividends in arrears.
Scientific Leasing has 5,000 shares of 7%, $100 par value cumulative preferred
stock outstanding, and the annual dividend is $35,000 (5,000 X $7 per share).
If dividends are 2 years in arrears, preferred stockholders are entitled to receive
the following dividends in the current year:
DIVIDENDS
A dividend is distribution by a corporation
to its stockholders on a pro rata (equal)
basis.
A cash dividend is a pro rata distribution of
cash to stockholders.
For a cash dividend to occur, a corporation
must have:
1 retained earnings,
2 adequate cash, and
3 declared dividends.
ENTRIES FOR
CASH DIVIDENDS
Three dates are important in connection with dividends: 1 the
declaration date, 2 the record date, and 3 the payment date.
Accounting entries are required on two of the dates – the
declaration date and the payment date. On the declaration date,
the board of directors formally declares the cash dividend and
announces it to the stockholders. An entry is required to
recognize the decrease in retained earnings and the increase in the
liability – Dividends Payable. On December 31, 2002, the
directors of Media General declare a $.50 per share cash dividend
on 100,000 shares of $10 par value common stock. The dividend
is $50,000 (100,000 X $.50), and the entry to record the
declaration:
Date Account Titles and Explanation Debit Credit
50,000
Dec. 31 Retained Earnings
Dividends Payable
(To record declaration of cash dividend) 50,000
ENTRIES FOR
CASH DIVIDENDS
Preferred stock has priority over common stock in regard to
dividends. Cash dividends must be paid to preferred stockholders
before common stockholders are paid any dividends. IBR Inc. has
1,000 shares of 8%, $100 par value cumulative preferred stock and
50,000 shares of $10 par value common stock outstanding at
December 31, 2002. The dividend per share for preferred stock is $8
($100 par value X 8%), and the required annual dividend for
preferred stock is $8,000 (1,000 X $8). The directors declare a
$6,000 cash dividend on December 31, 2002. The total dividend
amount goes to the preferred stockholders in this case due to their
dividend preference. The entry to record the dividend declaration
is:
Date Account Titles and Explanation Debit Credit
6,000
Dec. 31 Retained Earnings (or Dividends)
Dividends Payable
6,000
(To record $6 per share cash dividend to
preferred stockholders)
ILLUSTRATION 12-12
ALLOCATING DIVIDENDS TO
PREFERRED AND COMMON STOCK
Dividends Payable
(To record declaration of cash dividends of 50,000
75,000
50,000
25,000
ILLUSTRATION 12-14
STATEMENT PRESENTATION OF COMMON
STOCK DIVIDENDS DISTRIBUTABLE
50,000
50,000
ILLUSTRATION 12-15
STOCK DIVIDEND EFFECTS
Stock dividends change the composition of stockholders’ equity because a
portion of retained earnings is transferred to paid-in capital.
However, total stockholders’ equity remains the same.
Stock dividends also have no effect on the par or stated value per share, but the
number of shares outstanding increases.
These effects are shown below for Medland Corporation.
STOCK SPLITS
A stock split, like a stock dividend, involves the issuance of
additional shares of stock to stockholders according to
their percentage of ownership.
However, a stock split results in a reduction of par or
stated value per share.
The purpose of a stock split is to increase the marketability
of the stock by lowering its market value per share.
In a stock split, the number of shares is increased in the
same proportion that par or stated value per share is
decreased.
A stock split does not have any effect on total paid-in
capital, retained earnings, and total stockholders’ equity.
However, the number of shares outstanding increases.
ILLUSTRATION 12-16
STOCK SPLIT EFFECTS
Assume that Medland Corporation splits its 50,000 shares
of common stock on a 2-for-1 basis. Because a stock split
does not affect the balances in any stockholders’ equity
accounts, it is not necessary to journalize a stock split.
ILLUSTRATION 12-17 EFFECTS OF
STOCK SPLITS AND STOCK DIVIDENDS
DIFFERENTIATED
300,000
300,000
ILLUSTRATION 12-22
STATEMENT PRESENTATION OF
PRIOR PERIOD ADJUSTMENTS
Prior period adjustments are reported in the
retained earnings statement. They are added
to (or deducted from) the beginning retained
earnings balance to show the adjusted
beginning balance. General Microwave has a
beginning balance of $800,000 in retained
earnings and the prior period adjustment is
reported as follows:
ILLUSTRATION 12-23
DEBITS AND CREDITS TO
RETAINED EARNINGS
The retained earnings statement shows the changes
in retained earnings during the year. The
statement is prepared from the Retained Earnings
account. Transactions and events that affect
retained earnings are tabulated in account form as
shown below.
ILLUSTRATION 12-24
RETAINED EARNINGS STATEMENT
Net income increases retained earnings and a net loss decreases retained earnings.
Prior period adjustment may either increase or decrease retained earnings. Both
cash and stock dividends decrease retained earnings. Treasury stock transactions
may decrease retained earnings. The retained earnings statement for Graber Inc. is
as follows:
STOCKHOLDERS’ EQUITY
PRESENTATION AND ANALYSIS
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CHAPTER 12
CORPORATIONS: ORGANIZATION, STOCK
TRANSACTIONS, DIVIDENDS, AND RETAINED EARNINGS