Chapter 4

ACCOUNTING FOR
CORPORATIONS

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
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C1 CORPORATE FORM OF
ORGANIZATION
An
An entity
entity
created
created by
by law
law

Existence Privately Held

Existence is
is Ownership
separate
separate from
from can be
owners
owners

Has
Has rights
rights and
and
privileges
privileges
Publicly Held
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C1 CHARACTERISTICS OF
CORPORATIONS
Advantages
 Separate legal entity
 Limited liability of stockholders
 Transferable ownership rights
 Continuous life
 Lack of mutual agency for stockholders
 Ease of capital accumulation
Disadvantages
 Governmental regulation
 Corporate taxation
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C1 CORPORATE ORGANIZATION AND

MANAGEMENT

Stockholders

Board of Directors

President, Vice-President,
and Other Officers

Employees of the Corporation

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C1 CORPORATE ORGANIZATION AND

MANAGEMENT
C orporate O rganiza tion C hart
Stockholders
Ultimate
S tockholders usually meet
control
once a year
Selected by a
B oard of D irectors Overall
vote of the
responsibility
stockholders
for managing
P resident the company

S ecretary V ice P resident V ice P resident V ice P resident

Finance P roduction M arketing
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C1
RIGHTS OF STOCKHOLDERS

 Vote at stockholders’ meetings

 Sell stock
 Purchase additional shares of stock
 Receive dividends, if any
 Share equally in any assets remaining
after creditors are paid in a liquidation
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C1 STOCK CERTIFICATES AND

TRANSFER
Each unit of
ownership is
called a share of
stock.
A stock certificate
serves as proof
that a stockholder
has purchased
shares.

When the stock is sold, the stockholder signs a transfer

endorsement on the back of the stock certificate.
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C1
BASICS OF CAPITAL STOCK

Total amount of stock that a

corporation’s charter authorizes it to sell.

Total amount of stock that has been

issued or sold to stockholders.
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C1
BASICS OF CAPITAL STOCK


Par value is an
Market price is the
arbitrary amount
amount that each
assigned to each
share of stock will
share of stock when
sell for in the market.
it is authorized.

Classes of Stock
 Par Value
 No-Par Value
 Stated Value
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P1
ISSUING PAR VALUE STOCK
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for $25 per share.
Let’s record this transaction.

Dr Cr
Sept. 1 Cash 2,500,000
Common Stock, $2 par value 200,000
Paid-in Capital in Excess
of Par Value, Common 2,300,000
Issued 100,000 shares of common stock.
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P1 ISSUING PAR VALUE STOCK

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P1
ISSUING STOCK FOR NONCASH
ASSETS
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.

Dr Cr
Sept. 1 Land 2,500,000
Common Stock, $2 par value 200,000
Paid-in Capital in Excess 2,300,000
of Par Value, Common
Exchanged 100,000 common shares for land.
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P2
CASH DIVIDENDS
Regular cash dividends provide a return to investors
and almost always affect the stock’s market value.

Corporation Dividends Stockholders

To pay a cash dividend, the %o f Co rpo ra tio ns Pa ying Dive nds

corporation must have: 100%
75%
80%
1. A sufficient balance in 60%
retained earnings; and 40%
22%
2. The cash necessary to 20%
0%
pay the dividend. Co mmo n Pre fe rre d
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P2
ACCOUNTING FOR CASH DIVIDENDS

Three important dates

e nds
id
Div

Date of Declaration Date of Record Date of Payment

Record liability No entry Record payment of
for dividend. required. cash to stockholders.
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P2
ACCOUNTING FOR CASH DIVIDENDS
On January 19, a $1 per share cash dividend is declared
on Dana, Inc.’s 10,000 common shares outstanding. The
dividend will be paid on March 19 to stockholders of
record on February 19.

e nds
id
Div
Date of Declaration
Record liability
for dividend.
Dr Cr
Jan. 19 Retained Earnings 10,000
Common Dividend Payable 10,000
Declared $1 per share cash dividend.
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P2
ACCOUNTING FOR CASH DIVIDENDS
On January 19, a $1 per share cash dividend is declared
on Dana, Inc.’s 10,000 common shares outstanding. The
dividend will be paid on March 19 to stockholders of
record on February 19.
No entry required on February 19, the date of record.

Date of Payment
Record payment of
cash to stockholders.
Dr Cr
Mar. 19 Common Dividends Payable 10,000
Cash 10,000
Paid $1 per share cash dividend.
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P2
DEFICITS AND CASH DIVIDENDS
A deficit is created when a company incurs
cumulative losses or pays dividends greater
than total profits earned in other years.
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P2
STOCK DIVIDENDS
A distribution of a corporation’s own shares to its stockholders
without receiving any payment in return.
Why a stock dividend?
 Can be used to keep the market price on the stock affordable.
 Can provide evidence of management’s confidence that
the company is doing well.
Small Stock Dividend
Distribution is  25% of the previously outstanding shares.
Large Stock Dividend
Distribution is > 25% of the previously outstanding shares.
100 shares
HotAir, Inc.
Common Stock
$1 par
 13 - 19

P2
RECORDING A SMALL STOCK
DIVIDEND
Simmons has 100,000 shares of $1 par value stock outstanding. On
December 31, 2011, Simmons declared a 2% stock dividend, when the
stock was selling for $10 per share. The stock will be distributed to
stockholders on January 20, 2012. Let’s prepare the December 31 entry.

Capitalize retained earnings for the market

value of the shares to be distributed.
(100,000 × 2% = 2,000 × $10 = $20,000)
2,000 × $1 par

Dr Cr
Dec. 31 Retained Earnings 20,000
Common Stock Dividend Distributable 2,000
Paid-In Capital in Excess
of Par Value 18,000
Declared a 2,000 share (2%) stock dividend.
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P2

Before the
stock
dividend.

After the
stock
dividend.
 13 - 21

P2 RECORDING A LARGE STOCK

DIVIDEND
Router, Inc. has 50,000 shares of $1 par value stock
outstanding. On December 31, 2009, Router declared a 40%
stock dividend, when the stock was selling for $8 per share.
The stock will be distributed to stockholders on January 20,
2010. Let’s prepare the December 31 entry.

Capitalize retained earnings for the minimum amount required

by state law, usually par or stated value of the shares.
(50,000 × 40% = 20,000 shares × $1 par value = $20,000)

Dr Cr
Dec. 31 Retained Earnings 20,000
Common Stock Dividend Distributable 20,000
Declared a 20,000 share (40%) stock dividend.
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P2
STOCK SPLITS
A distribution of additional shares of stock to
stockholders according to their percent ownership.

$10 par value

Common Stock Old

Shares
100 shares

$5 par value
New
Shares Common Stock
200 shares
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C2
PREFERRED STOCK
A separate class of stock, typically having
priority over common shares in . . .
 Dividend distributions
 Distribution of assets in case of liquidation

Usually has a stated Normally has no

dividend rate voting rights
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C2
PREFERRED STOCK
Cumulative vs. Noncumulative
Dividends in arrears must Undeclared dividends from
be paid before dividends current and prior years do
may be paid on common not have to be paid in
stock. (Normal case) future years.

Consider the following Stockholders’ Equity section of

the Balance Sheet. The Board of Directors did not
declare or pay dividends in 2010. In 2011, the Board
declared and paid cash dividends of $42,000.
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C2
PREFERRED STOCK
If Preferred Stock is Noncumulative: Preferred Common
Year 2010: No dividends paid. $ - $ -
Year 2011:
1. Pay 2011 preferred dividend. $ 9,000
2. Remainder goes to common. $ 33,000

If Preferred Stock is Cumulative: Preferred Common

Year 2010: No dividends paid. $ - $ -
Year 2011:
1. Pay 2010 preferred dividend in arrears. $ 9,000
2. Pay 2011 preferred dividend. 9,000
3. Remainder goes to common. $ 24,000
Totals $ 18,000 $ 24,000
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C2
PREFERRED STOCK
Participating vs. Nonparticipating
Dividends may exceed a Dividends are limited to a
stated amount once maximum amount each year.
common stockholders The maximum is usually the
receive a dividend equal to stated dividend rate.
the preferred stated rate. (Normal case)

Reasons for Issuing Preferred Stock

 To raise capital without sacrificing control
 To boost the return earned by common stockholders
through financial leverage
 To appeal to investors who may believe the common
stock is too risky or that the expected return on
common stock is too low
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P3
TREASURY STOCK
Treasury stock represents shares of a company’s own
stock that has been acquired. Corporations might acquire
its own stock to:
1. Use their shares to buy other companies.
2. Avoid a hostile takeover.
3. Reissue to employees as compensation.
4. Support the market price.
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P3
PURCHASING TREASURY STOCK

On May 8, Whitt, Inc. purchased 2,000 of its own

shares of stock in the open market for $4 per share.
Dr Cr
May 8 Treasury stock, common 8,000
Cash 8,000
Purchase 2,000 treasury shares
at $4 per share.

Treasury stock is shown as a reduction in total

stockholders’ equity on the balance sheet.
 13 - 29

P3 SELLING TREASURY STOCK AT

COST
On June 30, Whitt sold 100 shares of
its treasury stock for $4 per share.

Dr Cr
June 30 Cash 400
Treasury stock, common 400
Sold 100 shares of treasury
for $4 per share.
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P3 SELLING TREASURY STOCK

ABOVE COST
On July 19, Whitt, Inc. sold an additional 500
shares of its treasury stock for $8 per share.

Dr Cr
July 19 Cash 4,000
Treasury Stock, common 2,000
Paid-In Capital, Treasury Stock 2,000
Sold 500 treasury shares for $8 per share.
 13 - 31

P3 SELLING TREASURY STOCK

BELOW COST
On August 27, Whitt sold an additional 400
shares of its treasury stock for $1.50 per share.

Dr Cr
Aug. 27 Cash 600
Paid-in Captial, Treasury Stock 1,000
Treasury Stock, Common 1,600
Sold 500 treasury shares for $1.50 per share.
 13 - 32

C3 STATEMENT OF RETAINED
EARNINGS
Retained earnings is the total cumulative amount of
reported net income less any net losses and dividends
declared since the company started operating.

Restricted Retained Earnings

Legal Restriction Contractual Restriction
Most states restrict Loan agreements
the amount of can include
treasury stock restrictions on paying
purchases to the dividends below a
amount of retained certain amount of
earnings. retained earnings.
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C3 APPROPRIATED RETAINED
EARNINGS
A corporation’s directors can voluntarily limit
dividends because of a special need for cash
such as the purchase of new facilities.
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C3 PRIOR PERIOD ADJUSTMENTS

Prior period adjustments are corrections of material
errors in past years’ financial statements that result in a
change in the beginning balance of retained earnings.
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C3 STATEMENT OF
STOCKHOLDERS’ EQUITY
Matrix,
Matrix, Inc.
Inc.
Statement
Statement ofof Stockholders'
Stockholders' Equity
Equity
For
For the
the Year
Year Ended
Ended December
December 31,
31, 2011
2011
Common
Common stockstock and
and
(In
(In millions)
millions) capital
capital in
in excess
excessof of par
par Retained
Retained
Shares
Shares Amount
Amount Earnings
Earnings Total
Total
Balance
Balance at at December
December 31,
31, 2010
2010 821
821 $$ 2,500
2,500 $$ 9,500
9,500 $$ 12,000
12,000
Stock
Stock sales
sales 17
17 500
500 500
500
Stock
Stock repurchases
repurchasesand
and retirement
retirement (17)
(17) (260)
(260) (925)
(925) (1,185)
(1,185)
Cash
Cash dividends
dividendsdeclared
declared (150)
(150) (150)
(150)
Other,
Other, net
net 70
70 70
70
Net
Net income
income 5,100
5,100 5,100
5,100
Balance
Balance at at December
December 31,
31, 2011
2011 821
821 $$ 2,740
2,740 $$ 13,595
13,595 $$ 16,335
16,335

This is a more inclusive statement than the statement of

retained earnings.
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C3
STOCK OPTIONS
The right to purchase common stock at a fixed price over a
specified period of time. As the stock’s price rises above
the fixed option price, the value of the option increases.

Market
Option price of
purchase stock $75
price $30 per share.
per share.

Options are given to key employees to motivate them to:

 focus on company performance,
 take a long-run perspective, and
 remain with the company.
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A1
EARNINGS PER SHARE
Earnings per share is one of the most widely
cited accounting statistics.

Basic
earnings = Net income - Preferred dividends
per share Weighted-average common shares outstanding
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A2
PRICE–EARNINGS RATIO
This ratio reveals information about the stock
market’s expectations for a company’s future growth
in earnings, dividends, and opportunities.

Price–
Market value per share
Earnings =
Ratio Earnings per share

If earnings go up,
will the market price
of my stock follow?
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A3
DIVIDEND YIELD

Tells us the annual amount of cash dividends

distributed to common stockholders relative to
the stock’s market price.

Dividend Annual cash dividends per share

=
Yield Market value per share
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A4

BOOK VALUE PER SHARE–COMMON

Reflects the amount of stockholders’ equity

applicable to common shares on a per share basis.

Stockholders’ equity applicable

Book value per to common shares
=
common share Number of common
shares outstanding
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A4 BOOK VALUE PER SHARE–

PREFERRED
Reflects the amount of stockholders’ equity
applicable to preferred shares on a per share basis.

Stockholders’ equity applicable

Book value per to preferred shares
=
preferred share Number of preferred shares
outstanding
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GLOBAL VIEW

U.S. GAAP and IFRS have similar procedures for issuing common
stock at par, at a premium, at a discount, and for noncash assets.

Accounting for and reporting cash dividends, stock dividends, and

stock splits, are consistent under both U.S. GAAP and IFRS.

Accounting for treasury stock is consistent under both U.S. GAAP and
IFRS. Companies do not report gains or losses on transactions
involving their own stock.
Preferred stock that is redeemable at the option of the preferred
stockholder is reported between liabilities and equity under U.S. GAAP,
but it is reported as a liability under IFRS. Also, the issue price of
convertible preferred stock (and bonds) is recorded entirely under
preferred stock (or bonds), and none to the conversion feature under
U.S. GAAP. However, IFRS requires that a portion of the issue price be
allocated to the conversion feature.
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END OF CHAPTER 13