Chapter 1 of Corporation Accounting PDF

Chapter 1 Corporation Accounting  www.downloadslide.net Accounting for Corporations Chapter Preview COMMON PREFERRED...

Chapter 1 Corporation Accounting  www.downloadslide.net Accounting for Corporations Chapter Preview COMMON PREFERRED TREASURY REPORTING DIVIDENDS STOCK STOCK STOCK AND ANALYSIS C1 Stock basics P2 Cash dividends C2 Issuance P3 Purchasing C3 Statements of treasury stock retained P1 Issuance at: Stock Dividend earnings and dividends preferences Reissuing Par value equity treasury stock Stock splits Convertible No-par value and callable Retiring stock A1 EPS Stated value Rationale A2 PE ratio Noncash A3 Dividend yield assets A4 Book value Le nin Ob cti s CONCEPTUAL ANALYTICAL PROCEDURAL C1 Identify characteristics of corporations A1 Compute earnings per share and P1 Record the issuance of corporate stock. and their organization. describe its use. P2 Record transactions involving cash C2 Explain characteristics of, and distribute A2 Compute price-earnings ratio and dividends, stock dividends, and stock dividends between, common and describe its use in analysis. splits. preferred stock. A3 Compute dividend yield and explain P3 Record purchases and sales of treasury C3 Explain the items reported in retained its use in analysis. stock and the retirement of stock. earnings. A4 Compute book value and explain its use in analysis.  www.downloadslide.net AP Images/Imaginechina Open Sesame HANGZHOU, CHINA—“In 1995 a friend showed me the ready to attack the market. “You’ve got to make your team Internet for the first time,” recalls Jack Ma. “We searched the have value, innovation, and vision,” insists Jack. “When you are word beer... [then we] discovered that there was no data small, you have to be very focused and rely on your brain.” about China. We decided to launch a website.” Jack never The success of Alibaba’s corporate-type structure and its looked back. “My dream was to set up my own e-commerce mix of creditor vs. equity financing brought both opportunities company,” explains Jack. “I gathered 17 people in my apartment and challenges. Jack explains the empowering of consumers. and spoke to them for two hours about my vision. Everyone put “It’s customers number one, employees two, and sharehold- their money on the table.” ers three,” declares Jack. “It’s the share- Jack then needed a company “Think about what social problem holders who when the crisis comes... name. “I was in San Francisco in a you could solve” ran away. My customers and my people coffee shop, and I was thinking —Jack Ma stayed.” The challenge is staying the Alibaba is a good name. Then a waitress came, and I said do course. “Nobody believed in me,” admits Jack. “[Moreover] you know about Alibaba? And she said yes. I said what do you do not allow your colleagues and employees to work for you. know about Alibaba, and she said ‘Open Sesame.’ And I said Instead, let them work for a common goal.” yes, this is the name! Then I went onto the street and found 30 There are new challenges on the horizon for Jack. One is people and asked them, ‘Do you know Alibaba?’ People from effectively leveraging accounting to achieve his current task: India, people from Germany, people from Tokyo and China... issuing Alibaba stock on the NYSE. This demands knowledge They all knew about Alibaba.” Thus, the Alibaba Group of corporate formation, stock types, and equity transactions. (AlibabaGroup.com) was born. Jack’s company is setting the stage for potentially the largest The success of Alibaba would not have been possible with- initial public offering since Facebook. out good decisions regarding creditor vs. equity financing. To Through it all, Jack remains humble. “I call myself ‘blind make it happen, the new company had to deal with corporate man riding on the back of a blind tiger.’” formation, equity issuance, stock types, retaining earnings, Sources: Alibaba website, September 2014; Inc., January 2008; and dividend policies. Jack eventually set up the Alibaba Group Upstart Business Journal, September 2011; Talk Asia, April 2006; South China Morning Post, July 2013; Jungle News, May 2014; Vulcan Post, as a corporate-type entity. With his structure in place, Jack was February 2014 531  www.downloadslide.net 532 Chapter 13 Accounting for Corporations CORPORATE FORM OF ORGANIZATION C1 A corporation is an entity created by law that is separate from its owners. It has most of the rights and privileges granted to individuals. Owners of corporations are called stockholders or Identify characteristics of corporations and their shareholders. Corporations can be separated into two types. A privately held (or closely held) organization. corporation does not offer its stock for public sale and usually has few stockholders. A publicly held corporation offers its stock for public sale and can have thousands of stockholders. Public sale usually refers to issuance of stock and trading on an organized stock market. Characteristics of Corporations Corporations represent an important type of organization. Their unique characteristics offer advantages and disadvantages. Advantages of Corporate Form Separate legal entity: A corporation conducts its affairs with the same rights, duties, and re- sponsibilities of a person. It takes actions through its agents, who are its officers and managers. Limited liability of stockholders: Stockholders are liable for neither corporate acts nor corporate debt. Point: The business entity as- Transferable ownership rights: The transfer of shares from one stockholder to another usu- sumption requires a corporation ally has no effect on the corporation or its operations except when this causes a change in the to be accounted for separately from its owners (shareholders). directors who control or manage the corporation. Continuous life: A corporation’s life continues indefinitely because it is not tied to the phys- ical lives of its owners. Lack of mutual agency for stockholders: A corporation acts through its agents, who are its officers and managers. Stockholders, who are not its officers and managers, do not have the power to bind the corporation to contracts—referred to as lack of mutual agency. Ease of capital accumulation: Buying stock is attractive to investors because (1) stockhold- ers are not liable for the corporation’s acts and debts, (2) stocks usually are transferred easily, (3) the life of the corporation is unlimited, and (4) stockholders are not corporate agents. These advantages enable corporations to accumulate large amounts of capital from the com- bined investments of many stockholders. Disadvantages of Corporate Form Government regulation: A corporation must meet requirements of a state’s incorporation Point: Proprietorships and partnerships are not subject to laws, which subject the corporation to state regulation and control. Proprietorships and part- income taxes. Their income is nerships avoid many of these regulations and governmental reports. taxed as the personal income Corporate taxation: Corporations are subject to the same property and payroll taxes as pro- of their owners. prietorships and partnerships plus additional taxes. The most burdensome of these are federal Point: Double taxation is less and state income taxes that together can take 40% or more of corporate pretax income. severe when a corporation’s Moreover, corporate income is usually taxed a second time as part of stockholders’ personal owner-manager collects a salary that is taxed only once as part income when they receive cash distributed as dividends. This is called double taxation. of his or her personal income. (Dividends are normally taxed at the individual’s income tax rate; for “qualified” dividends, At year-end, many small corpo- the tax rate is 0%, 15%, or 20%, depending on the individual’s tax bracket.) rations distribute bonuses to owner-managers equal to the corporation’s income. This reduces corporate income to Decision Insight $0 and avoids double taxation. Stock Financing Mark Zuckerberg took his company, Facebook, public by issu- ing its first shares on the Nasdaq exchange. The initial public offering (IPO) of Facebook shares raised billions in equity financing. It also raised the importance of accounting reports versus market hype. The IPO of Facebook shares came eight years after the company was founded by Zuckerberg in his college dorm room. AP Images/Nasdaq via Facebook, Zef Nikolla  www.downloadslide.net Chapter 13 Accounting for Corporations 533 Corporate Organization and Management This section describes the incorporation, costs, and management of corporate organizations. Point: A corporation is not Incorporation A corporation is created by obtaining a charter from a state government. A required to have an office in charter application usually must be signed by the prospective stockholders called incorporators its state of incorporation. or promoters and then filed with the proper state official. When the application process is com- Delaware is viewed as having favorable corporate laws and plete and fees paid, the charter is issued and the corporation is formed. Investors then purchase about half of all corporations the corporation’s stock, meet as stockholders, and elect a board of directors. Directors oversee a listed on the NYSE are incor- corporation’s affairs. porated there. Organization Expenses Organization expenses (also called organization costs) are the costs to organize a corporation; they include legal fees, promoters’ fees, and amounts paid to obtain a charter. The corporation records (debits) these costs to an expense account called Organization Expenses. Organization costs are expensed as incurred because it is difficult to determine the amount and timing of their future benefits. Management of a Corporation The ultimate con- EXHIBIT 13.1 trol of a corporation rests with stockholders who control Corporate Structure a corporation by electing its board of directors, or sim- ply, directors. Each stockholder usually has one vote for Stockholders each share of stock owned. This control relation is shown Corporate governance is the system by which in Exhibit 13.1. Directors are responsible for and have Board of Directors companies are directed final authority for managing corporate activities. A board and controlled. can act only as a collective body and usually limits its President, Vice President, and Other Officers actions to setting general policy. A corporation usually holds a stockholder meeting at least once a year to elect directors and transact business Employees of the Corporation as its bylaws require. A group of stockholders owning or controlling votes of more than a 50% share of a corpora- tion’s stock can elect the board and control the corporation. Stockholders who do not attend stockholders’ meetings must have an opportunity to delegate their voting rights to an agent by signing a proxy, a document that gives a designated agent the right to vote the stock. Day-to-day direction of corporate business is delegated to executive officers appointed by the board. A corporation’s chief executive officer (CEO) is often its president. Several vice presi- Point: Bylaws are guidelines dents, who report to the president, are commonly assigned specific areas of management re- that govern the behavior of sponsibility such as finance, production, and marketing. One person often has the dual role of individuals employed by and managing the corporation. chairperson of the board of directors and CEO. In this case, the president is usually designated the chief operating officer (COO). Decision Insight Seed Money Sources for start-up money include (1) “angel” investors such as Global: Some corporate family, friends, or anyone who believes in a company, (2) employees, investors, and labels are: Country Label even suppliers who can be paid with stock, and (3) venture capitalists (investors) United States...... Inc. who have a record of entrepreneurial success. See the National Venture Capital France............ SA Association (NVCA.org) for information. United Kingdom Public........... PLC Private.......... Ltd Stockholders of Corporations Germany & Austria Public........... AG This section explains stockholder rights, stock purchases and sales, and the role of registrars and Private............ GmbH transfer agents. Sweden & Finland... AB Italy.............. SpA Rights of Stockholders When investors buy stock, they acquire all specific rights the cor- Netherlands....... NV Australia.......... AG poration’s charter grants to stockholders. They also acquire general rights granted stockholders Mexico............ SA by the laws of the state in which the company is incorporated. When a corporation has only one Bahamas.......... IBC  www.downloadslide.net 534 Chapter 13 Accounting for Corporations class of stock, it is identified as common stock. State laws vary, but common stockholders usu- ally have the general right to 1. Vote at stockholders’ meetings (or register proxy votes electronically). 2. Sell or otherwise dispose of their stock. 3. Purchase their proportional share of any common stock later issued by the corporation. This preemptive right protects stockholders’ proportionate interest in the corporation. For example, a stockholder who owns 25% of a corporation’s common stock has the first opportunity to buy 25% of any new common stock issued. 4. Receive the same dividend, if any, on each common share of the corporation. 5. Share in any assets remaining after creditors and preferred stockholders are paid when, and if, the corporation is liquidated. Each common share receives the same amount. Stockholders also have the right to receive timely financial reports. Stock Certificates and Transfer Investors who buy a corporation’s stock sometimes receive a stock certificate as proof of share ownership. Many corporations issue only one certifi- cate for each block of stock EXHIBIT 13.2 purchased. A certificate can Stock Certificate be for any number of shares. Exhibit 13.2 shows a stock certificate of the Green Bay Packers. A certificate shows the com- pany name, stockholder name, number of shares, and other crucial informa- tion. Issuance of certificates Point: The Green Bay is becoming less common. Packers is the only nonprofit, Instead, many stockholders community-owned major league professional sports maintain accounts with the team. The NFL now prohibits corporation or their stock- any other teams from becom- brokers and never receive ing community-owned. Courtesy of JJW Images actual certificates. Registrar and Transfer Agents If a corporation’s stock is traded on a major stock ex- change, the corporation must have a registrar and a transfer agent. A registrar keeps stockholder records and prepares official lists of stockholders for stockholder meetings and dividend pay- ments. A transfer agent assists with purchases and sales of shares by receiving and issuing cer- tificates as necessary. Registrars and transfer agents are usually large banks or trust companies with computer facilities and staff to do this work. Decision Insight Pricing Stock A prospectus accompanies a stock’s initial public offering (IPO), giving financial information about the company issuing the stock. A prospectus should help answer these questions to price an IPO: (1) Is the underwriter reliable? (2) Is there growth in revenues, profits, and cash flows? (3) What is management’s view of operations? (4) Are current owners selling? (5) What are the risks? Basics of Capital Stock Capital stock is a general term that refers to any shares issued to obtain capital (owner financ- ing). This section introduces terminology and accounting for capital stock. Authorized Stock Authorized stock is the number of shares that a corporation’s charter allows it to sell. The number of authorized shares usually exceeds the number of shares issued (and outstanding), often by a large amount. (Outstanding stock refers to issued stock held by  www.downloadslide.net Chapter 13 Accounting for Corporations 535 stockholders.) No formal journal entry is required for stock authorization. A corporation Subcategories of Authorized Stock must apply to the state for a change in its charter if it wishes to issue more shares than previously authorized. A corporation discloses the number of shares authorized in the Authorized equity section of its balance sheet or notes. Apple’s balance sheet reports 1.8 billion common shares authorized as of the start of its 2014 fiscal year. Authorized & Issued Selling (Issuing) Stock A corporation can sell stock directly or indirectly. To sell directly, it advertises its stock issuance to potential buyers. This type of issuance is most Authorized, Issued, and common with privately held corporations. To sell indirectly, a corporation pays a bro- Outstanding kerage house (investment banker) to issue its stock. Some brokerage houses underwrite an indirect issuance of stock; that is, they buy the stock from the corporation and take all gains or losses from its resale. The innermost box shows that shares issued decline Market Value of Stock Market value per share is the price at which a stock is if a company buys back its previously issued stock. bought and sold. Expected future earnings, dividends, growth, and other company and economic factors influence market value. Traded stocks’ market values are available daily in newspapers such as The Wall Street Journal and online. The current market value of previously issued shares (for example, the price of stock in trades between investors) does not impact the issuing corporation’s stockholders’ equity. Classes of Stock When all authorized shares have the same rights and characteristics, the stock is called common stock. A corporation is sometimes authorized to issue more than one class of stock, including preferred stock and different classes of common stock. American Greetings, for instance, has two types of common stock: Class A stock has 1 vote per share and Class B stock has 10 votes per share. Par Value Stock Par value stock is stock that is assigned a par value, which is an amount assigned per share by the corporation in its charter. For example, Monster Worldwide, Inc.’s common stock has a par value of $0.001. Other commonly assigned par values are $10, $5, $1 and $0.01. There is no restriction on the assigned par value. In many Point: Managers are moti- states, the par value of a stock establishes minimum legal capital, which refers to the least vated to set a low par value amount that the buyers of stock must contribute to the corporation or be subject to paying at when minimum legal capital or state issuance taxes are based a future date. For example, if a corporation issues 1,000 shares of $10 par value stock, the on par value. corporation’s minimum legal capital in these states would be $10,000. Minimum legal capi- tal is intended to protect a corporation’s creditors. Since creditors cannot demand payment Point: Minimum legal capital was intended to protect credi- from stockholders’ personal assets, their claims are limited to the corporation’s assets and tors by requiring a minimum any minimum legal capital. At liquidation, creditor claims are paid before any amounts are level of net assets. distributed to stockholders. No-Par Value Stock No-par value stock, or simply no-par stock, is stock not assigned a Point: Par, no-par, and stated value per share by the corporate charter. Its advantage is that it can be issued at any price with- value do not set the stock’s market value. out the possibility of a minimum legal capital deficiency. Stated Value Stock Stated value stock is no-par stock to Corporation EXHIBIT 13.3 which the directors assign a “stated” value per share. Stated value per share becomes the minimum legal capital per share in Common Stock Equity Composition Total Paid-In Capital this case. Normal bal. Stockholders’ Equity A corporation’s equity is known as Paid-In Capital stockholders’ equity, also called shareholders’ equity or corpo- in Excess of Par rate capital. Stockholders’ equity consists of (1) paid-in (or con- Point: Paid-in capital comes tributed) capital and (2) retained earnings; see Exhibit 13.3. Normal bal. from stock-related transactions, Paid-in capital is the total amount of cash and other assets the whereas retained earnings corporation receives from its stockholders in exchange for its Retained Earnings comes from operations; if Retained Earnings has a debit stock. Retained earnings is the cumulative net income (and loss) Normal bal. balance, it is often titled not distributed as dividends to its stockholders. Accumulated Deficit.  www.downloadslide.net 536 Chapter 13 Accounting for Corporations Decision Insight Stock Quote The Target stock quote is 52 Weeks Yld Vol Net interpreted as (left to right): Hi, highest price Hi Lo Sym Div % PE mil. Hi Lo Close Chg in past 52 weeks; Lo, lowest price in past 52 58.95 45.28 TGT 1.20 2.07 13.5 668 58.06 57.40 57.63 20.30 weeks; Sym, company exchange symbol; Div, dividends paid per share in past year; Yld %, dividend divided by closing price; PE, stock price per share QC1 divided by earnings per share; Vol mil., number (in millions) of shares traded; Hi, highest price for the day; Lo, lowest price for the day; Close, closing price for the day; Net Chg, change in closing price from prior day. COMMON STOCK P1 Record the issuance of Accounting for the issuance of common stock affects only paid-in (contributed) capital ac- counts; no retained earnings accounts are affected. corporate stock. Issuing Par Value Stock Par value stock can be issued at par, at a premium (above par), or at a discount (below par). In each case, stock can be exchanged for either cash or noncash assets. Issuing Par Value Stock at Par When common stock is issued at par value, we record amounts for both the asset(s) received and the par value stock issued. To illustrate, the entry to record Dillon Snowboards’s issuance of 30,000 shares of $10 par value stock for $300,000 cash on June 5, 2015, follows: Assets 5 Liabilities 1 Equity June 5 Cash......................................... 300,000 1300,000 1300,000 Common Stock, $10 Par Value................ 300,000 $10 par value 3 30,000 shares Issued 30,000 shares of $10 par value common stock at par. Exhibit 13.4 shows the stockholders’ equity of Dillon Snowboards at year-end 2015 (its first year of operations) after income of $65,000 and no dividend payments. EXHIBIT 13.4 Stockholders’ Equity Stockholders’ Equity for Common Stock—$10 par value; 50,000 shares authorized; Stock Issued at Par 30,000 shares issued and outstanding................................................ $300,000 Retained earnings.................................................................. 65,000 Total stockholders’ equity........................................................... $365,000 Issuing Par Value Stock at a Premium A premium on stock occurs when a corpora- Point: A premium is the tion sells its stock for more than par (or stated) value. To illustrate, if Dillon Snowboards is- amount by which issue price exceeds par (or stated) value. sues its $10 par value common stock at $12 per share, its stock is sold at a $2 per share It is recorded in the “Paid-In premium. The premium, known as paid-in capital in excess of par value, is reported as part Capital in Excess of Par Value, of equity; it is not revenue and is not listed on the income statement. The entry to record Common Stock” account; also called “Additional Paid-In Dillon Snowboards’s issuance of 30,000 shares of $10 par value stock for $12 per share on Capital, Common Stock.” June 5, 2015, follows: Assets 5 Liabilities 1 Equity 1360,000 1300,000 June 5 Cash......................................... 360,000 160,000 Common Stock, $10 Par Value................ 300,000 $10 par value 3 30,000 shares Paid-In Capital in Excess of Par Value, Common Stock.............. 60,000 [$12 issue price 2 $10 par Sold and issued 30,000 shares of $10 par value] 3 30,000 shares value common stock at $12 per share.  www.downloadslide.net Chapter 13 Accounting for Corporations 537 The Paid-In Capital in Excess of Par Value account is added to the par value of the stock in the Point: The paid-in capital terminology is interchangeable equity section of the balance sheet as shown in Exhibit 13.5. with contributed capital. EXHIBIT 13.5 Stockholders’ Equity Stockholders’ Equity for Common Stock — $10 par value; 50,000 shares authorized; Stock Issued at a Premium 30,000 shares issued and outstanding................................................ $300,000 Paid-in capital in excess of par value, common stock............................... 60,000 Retained earnings.................................................................. 65,000 Total stockholders’ equity........................................................... $425,000 Issuing Par Value Stock at a Discount A discount on stock occurs when a corporation sells its stock for less than par (or stated) value. Most states prohibit the issuance of stock at a discount. In states that allow stock to be issued at a discount, its buyers usually become contin- Point: Retained earnings can gently liable to creditors for the discount. If stock is issued at a discount, the amount by which be negative, reflecting accumu- issue price is less than par is debited to a Discount on Common Stock account, a contra to the lated losses. Pandora Media had an accumulated deficit of Common Stock account, and its balance is subtracted from the par value of stock in the equity $167 million at the start of section of the balance sheet. This discount is not an expense and does not appear on the income 2014. statement. Issuing No-Par Value Stock When no-par stock is issued and is not assigned a stated value, the amount the corporation re- ceives becomes legal capital and is recorded as common stock. This means that the entire pro- ceeds are credited to a no-par stock account. To illustrate, a corporation records its October 20 issuance of 1,000 shares of no-par stock for $40 cash per share as follows: Oct. 20 Cash......................................... 40,000 Assets 5 Liabilities 1 Equity Common Stock, No-Par Value................ 40,000 140,000 140,000 Issued 1,000 shares of no-par value common stock $40 issue price 3 1,000 no-par at $40 per share. shares Issuing Stated Value Stock Frequency of Stock Types When no-par stock is issued and assigned a stated value, its stated value becomes legal capital and is credited to a stated value stock account. Assuming that stated value stock is issued at an amount in excess of stated value (the usual case), the excess is credited to Stated 3% Par 88% Paid-In Capital in Excess of Stated Value, Common Stock, which is reported in the stock- No-Par 9% holders’ equity section. To illustrate, a corporation that issues 1,000 shares of no-par common stock having a stated value of $40 per share in return for $50 cash per share records this as follows: Oct. 20 Cash......................................... 50,000 Assets 5 Liabilities 1 Equity 150,000 140,000 Common Stock, $40 Stated Value............. 40,000 110,000 Paid-In Capital in Excess of Stated Value, Common Stock.................... 10,000 $40 stated value 3 1,000 shares Issued 1,000 shares of $40 per share stated value stock at $50 per share. [$50 issue price 2 $40 stated value] 3 1,000 shares Issuing Stock for Noncash Assets A corporation can receive assets other than cash in exchange for its stock. (It can also assume Point: Stock issued for non- liabilities on the assets received such as a mortgage on property received.) The corporation re- cash assets should be recorded cords the assets received at their market values as of the date of the transaction. The stock given at the market value of either the stock or the noncash asset, in exchange is recorded at its par (or stated) value with any excess recorded in the Paid-In whichever is more clearly Capital in Excess of Par (or Stated) Value account. (If no-par stock is issued, the stock is determinable.  www.downloadslide.net 538 Chapter 13 Accounting for Corporations recorded at the assets’ market value.) To illustrate, the entry to record receipt of land valued at $105,000 in return for issuance of 4,000 shares of $20 par value common stock on June 10 is Assets 5 Liabilities 1 Equity June 10 Land......................................... 105,000 1105,000 180,000 Common Stock, $20 Par Value................ 80,000 125,000 Paid-In Capital in Excess of Par Value, $20 par value 3 4,000 shares Common Stock.......................... 25,000 Exchanged 4,000 shares of $20 par value $105,000 asset value 2 common stock for land. $80,000 par value A corporation sometimes gives shares of its stock to promoters in exchange for their services Point: Any type of stock can in organizing the corporation, which the corporation records as organization expenses. The be issued for noncash assets. entry to record receipt of services valued at $12,000 in organizing the corporation in return for 600 shares of $15 par value common stock on June 5 is Assets 5 Liabilities 1 Equity June 5 Organization Expenses.......................... 12,000 212,000 19,000 Common Stock, $15 Par Value................ 9,000 13,000 Paid-In Capital in Excess of Par Value, Common Stock.......................... 3,000 $15 par value 3 600 shares Gave promoters 600 shares of $15 par value common stock in exchange for their services. $12,000 services value 2 $9,000 par value NEED-TO-KNOW 13-1 Prepare journal entries to record the following four separate (independent) issuances of stock. 1. A corporation issued 80 shares of $5 par value common stock for $700 cash. Recording Stock 2. A corporation issued 40 shares of no-par common stock to its promoters in exchange for their efforts, Issuance estimated to be worth $800. The stock has a $1 per share stated value. P1 3. A corporation issued 40 shares of no-par common stock in exchange for land, estimated to be worth $800. The stock has no stated value. 4. A corporation issued 20 shares of $30 par value preferred stock for $900 cash. Solution 1. Cash....................................................... 700 Common Stock, $5 Par Value*.............................. 400 Paid-In Capital in Excess of Par Value, Common Stock**......... 300 Issued common stock for cash. *80 shares 3 $5 per share 5 $400 **$700 2 $400 5 $300 2. Organization Expenses......................................... 800 Common Stock, $1 Stated Value............................ 40 Paid-In Capital in Excess of Stated Value, Common Stock........ 760 Issued stock to promoters. 3. Land....................................................... 800 Common Stock, No-Par Value.............................. 800 Issued stock in exchange for land. Do More: QS 13-2, QS 13-3, 4. Cash....................................................... 900 QS 13-4, QS 13-5, E 13-2, Preferred Stock, $30 Par Value*............................. 600 E 13-3, E 13-4 Paid-In Capital in Excess of Par Value, Preferred Stock**.......... 300 Issued preferred stock for cash. QC2 *20 shares 3 $30 per share 5 $600 **$900 2 $600 5 $300  www.downloadslide.net Chapter 13 Accounting for Corporations 539 DIVIDENDS This section describes both cash and stock dividend transactions. P2 Record transactions Cash Dividends involving cash dividends, stock dividends, and stock The decision to pay cash dividends rests with the board of directors and involves more than splits. evaluating the amounts of retained earnings and cash. The directors, for instance, may decide to keep the cash to invest in the corporation’s growth, to meet emergencies, to take advantage of unexpected opportunities, or to pay off debt. Alternatively, many corporations pay cash divi- dends to their stockholders at regular dates. These cash flows provide a return to investors and almost always affect the stock’s market value. Accounting for Cash Dividends Dividend payment in- Percent of Corporations Paying Dividends volves three important dates: declaration, record, and payment. Date of declaration is the date the directors vote to declare and pay Cash Dividend 75% to Common a dividend. This creates a legal liability of the corporation to its stockholders. Date of record is the future date specified by the di- rectors for identifying those stockholders listed in the corporation’s Cash Dividend to Preferred 22% records to receive dividends. The date of record usually follows the date of declaration by at least two weeks. Persons who own stock 0% 20% 40% 60% 80% 100% on the date of record receive dividends. Date of payment is the date when the corporation makes payment; it follows the date of record by enough time to allow the corporation to arrange checks, money transfers, or other means to pay dividends. To illustrate, the entry to record a January 9 declaration of a $1 per share cash dividend by the directors of Z-Tech, Inc., with 5,000 outstanding shares is Date of Declaration Jan. 9 Retained Earnings.............................. 5,000 Assets 5 Liabilities 1 Equity Common Dividend Payable................... 5,000 15,000 25,000 Declared $1 per common share cash dividend.1 $1 per share declared dividend 3 5,000 outstanding shares Common Dividend Payable is a current liability. The date of record for the Z-Tech dividend is January 22. No formal journal entry is needed on the date of record. The February 1 date of payment requires an entry to record both the settlement of the liability and the reduction of the cash balance, as follows: Date of Payment Feb. 1 Common Dividend Payable....................... 5,000 Assets 5 Liabilities 1 Equity Cash..................................... 5,000 25,000 25,000 Paid $1 per common share cash dividend. Deficits and Cash Dividends A corporation with a debit (abnormal) balance for Retained Point: It is often said a divi- dend is a distribution of re- Earnings is said to have a retained earnings deficit, which arises when a company incurs cu- tained earnings, but it is more mulative losses and/or pays more dividends than total earnings from current and prior years. A precise to describe a dividend deficit is reported as a deduction on the balance sheet, as shown in Exhibit 13.6. Most states as a distribution of assets to satisfy stockholder claims. prohibit a corporation with a deficit from paying a cash dividend to its stockholders. This legal restriction is designed to protect creditors by preventing distribution of assets to stockholders Point: The Retained Earnings when the company may be in financial difficulty. Deficit account is also called Accumulated Deficit. 1 An alternative entry is to debit Dividends instead of Retained Earnings. The balance in Dividends is then closed to Retained Earnings at the end of the reporting period. The effect is the same: Retained Earnings is decreased and a Dividend Payable is increased. For simplicity, all assignments in this chapter use the Retained Earnings account to record dividend declarations.  www.downloadslide.net 540 Chapter 13 Accounting for Corporations EXHIBIT 13.6 Common stock — $10 par value, 5,000 shares authorized, issued, and outstanding......... $50,000 Stockholders’ Equity with Retained earnings deficit.................................................... (6,000) a Deficit Total stockholders’ equity...................................................... $44,000 Point: Amazon.com has Some state laws allow cash dividends to be paid by returning a portion of the capital contrib- never declared a cash dividend. uted by stockholders. This type of dividend is called a liquidating cash dividend, or simply liquidating dividend, because it returns a part of the original investment back to the stockhold- QC3 ers. This requires a debit entry to one of the contributed capital accounts instead of Retained Earnings at the declaration date. Stock Dividends A stock dividend, declared by a corporation’s directors, is a distribution of additional shares of the corporation’s own stock to its stockholders without the receipt of any payment in return. Stock dividends and cash dividends are different. A stock dividend does not reduce assets and equity but instead transfers a portion of equity from retained earnings to contributed capital. Reasons for Stock Dividends Stock dividends exist for at least two reasons. First, direc- tors are said to use stock dividends to keep the market price of the stock affordable. For exam- ple, if a corporation continues to earn income but does not issue cash dividends, the price of its common stock likely increases. The price of such a stock may become so high that it discour- ages some investors from buying the stock (especially in lots of 100 and 1,000). When a corpo- ration has a stock dividend, it increases the number of outstanding shares and lowers the per share stock price. Another reason for a stock dividend is to provide evidence of management’s confidence that the company is doing well and will continue to do well. Accounting for Stock Dividends A stock dividend affects the components of equity by transferring part of retained earnings to contributed capital accounts, sometimes described as capi- talizing retained earnings. Accounting for a stock dividend depends on whether it is a small or large stock dividend. A small stock dividend is a distribution of 25% or less of previously outstanding shares. It is recorded by capitalizing retained earnings for an amount equal to the market value of the shares to be distributed. A large stock dividend is a distribution of more Five Steps to Record Stock Dividends than 25% of previously outstanding shares. A large stock dividend is recorded Step 1: Identify number of shares outstanding Step 2: Identify the stock dividend percentage by capitalizing retained earnings for the minimum amount required by state Step 3: Compute number of new shares (Step 1 3 Step 2) law governing the corporation. Most states require capitalizing retained earn- Step 4: Value new shares at market (small stock dividend) ings equal to the par or stated value of the stock. or par (large stock dividend) To illustrate stock dividends, we use the equity section of Quest’s balance Step 5: Determine debit (reduction) to Retained Earnings sheet shown in Exhibit 13.7 just before its declaration of a stock dividend on (Step 3 3 Step 4) December 31. EXHIBIT 13.7 Stockholders’ Equity Before Dividend Stockholders’ Equity Common stock—$10 par value, 15,000 shares authorized, before a Stock Dividend 10,000 shares issued and outstanding.......................................... $100,000 Paid-in capital in excess of par value, common stock................................ 8,000 Retained earnings............................................................ 35,000 Total stockholders’ equity..................................................... $143,000 Point: Small stock dividends Recording a small stock dividend. Assume that Quest’s directors declare a 10% stock dividend are recorded at market value. on December 31. This stock dividend of 1,000 shares, computed as 10% of its 10,000 outstand- ing shares, is to be distributed on January 20 to the stockholders of record on January 15. Since Assets 5 Liabilities 1 Equity the market price of Quest’s stock on December 31 is $15 per share, this small stock dividend 215,000 110,000 declaration is recorded as follows: 15,000 Date of Declaration—Small Stock Dividend 10% dividend 3 10,000 outstanding shares 3 $10 par value Dec. 31 Retained Earnings.............................. 15,000 Common Stock Dividend Distributable......... 10,000 Paid-In Capital in Excess of Par Value, 10% dividend 3 10,000 outstanding shares 3 [$15 Common Stock.......................... 5,000 market price 2 $10 par value] Declared a 1,000-share (10%) stock dividend.  www.downloadslide.net Chapter 13 Accounting for Corporations 541 The $10,000 credit in the declaration entry equals the par value of the shares and is recorded in Common Stock Dividend Distributable, an equity account. Its balance exists only until the shares are issued. The $5,000 credit equals the amount by which market value exceeds par value. This Point: The term Distributable (not Payable) is used for stock amount increases the Paid-In Capital in Excess of Par Value account in anticipation of the issuance dividends. A stock dividend is of shares. In general, the balance sheet changes in three ways when a stock dividend is declared. never a liability because it never First, the amount of equity attributed to common stock increases; for Quest, from $100,000 to reduces assets. $110,000 for 1,000 additional declared shares. Second, paid-in capital in excess of par increases Point: The credit to Paid-In by the excess of market value over par value for the declared shares. Third, retained earnings de- Capital in Excess of Par Value is creases, reflecting the transfer of amounts to both common stock and paid-in capital in excess of recorded when the stock divi- dend is declared. This account par. The impact on stockholders’ equity of Quest is shown in Exhibit 13.8 when its 10% stock is not affected when stock is dividend is declared on December 31— see the “declaration” column. later distributed. EXHIBIT 13.8 Before After Stockholders’ Equity Dividend Declaration Issuance Dividend Stockholders’ Equity after a Stock Dividend Common stock—$10 par value, 15,000 shares authorized, 10,000 shares issued and outstanding...... $100,000 $ — $ 10,000 $110,000 Common stock dividend distributable—1,000 shares..... — 10,000 (10,000) 0 Paid-in capital in excess of par value, common stock..... 8,000 5,000 — 13,000 Retained earnings................................. 35,000 (15,000) — 20,000 Total stockholders’ equity.......................... $143,000 $ 0 $ 0 $143,000 No entry is made on the date of record for a stock dividend. On January 20, the date of payment, Quest distributes the new shares to stockholders and records this entry (this entry is reflected in the “issuance” column of Exhibit 13.8): Date of Payment—Small Stock Dividend Jan. 20 Common Stock Dividend Distributable............. 10,000 Assets 5 Liabilities 1 Equity Common Stock, $10 Par Value................ 10,000 210,000 110,000 To record issuance of common stock dividend. The combined effect of these stock dividend entries is to transfer (or capitalize) $15,000 of re- tained earnings to paid-in capital accounts (see far-right column of Exhibit 13.8). The amount of Point: A stock dividend does capitalized retained earnings equals the market value of the 1,000 issued shares ($15 3 1,000 not affect total assets nor total shares). A stock dividend has no effect on the ownership percentage of individual stockholders. equity. Recording a large stock dividend. A corporation capitalizes retained earnings equal to the minimum amount required by state law for a large stock dividend. For most states, this amount is the par or stated value of the newly issued shares. To illustrate, suppose Quest’s board declares Point: Large stock dividends a stock dividend of 30% instead of 10% on December 31. Since this dividend is more than 25%, are recorded at par or stated it is treated as a large stock dividend. Thus, the par value of the 3,000 (computed as 10,000 value. outstanding shares 3 30%) dividend shares is capitalized at the date of declaration with this entry: Date of Declaration—Large Stock Dividend Dec. 31 Retained Earnings.............................. 30,000 Assets 5 Liabilities 1 Equity Common Stock Dividend Distributable......... 30,000 230,000 130,000 Declared a 3,000-share (30%) stock dividend. 30% dividend 3 10,000 outstanding This transaction decreases retained earnings and increases contributed capital by $30,000. On shares 3 $10 par value the date of payment the company debits Common Stock Dividend Distributable and credits Common Stock for $30,000. The effects from a large stock dividend on balance sheet accounts are similar to those for a small stock dividend except for the absence of any effect on paid-in capital in excess of par. Stock Splits A stock split is the distribution of additional shares to stockholders according to their percent ownership. When a stock split occurs, the corporation “calls in” its outstanding shares and is- sues more than one new share in exchange for each old share. Splits can be done in any ratio,  www.downloadslide.net 542 Chapter 13 Accounting for Corporations Before 5;1 Split: 1 share, $50 par including 2-for-1, 3-for-1, or higher. In 2012, Google directors approved a 2-for-1 stock split. Stock splits reduce the par or stated value per share. The reasons for stock splits are STOCK similar to those for stock dividends. To illustrate, CompTec has 100,000 outstanding shares of $20 par value common stock with a current market value of $88 per share. A 2-for-1 stock split cuts par value in half as it replaces 100,000 shares of $20 par value stock with 200,000 shares of $10 par value stock. Market value is reduced from $88 per share to about $44 per share. The split does not affect any equity amounts reported on the balance sheet or any in- After 5;1 Split: 5 shares, $10 par dividual stockholder’s percent ownership. Both the Paid-In Capital and Retained Earnings accounts are unchanged by a split, and no journal entry is made. The only STOCK effect on the accounts is a change in the stock account description. CompTec’s 2-for-1 split on its $20 par value stock means that after the split, it changes its stock account title to Common Stock, $10 Par Value. This stock’s description on the balance sheet also changes to reflect the additional authorized, issued, and outstanding shares and the new par value. The difference between stock splits and large stock dividends is often blurred. Many Point: Berkshire Hathaway companies report stock splits in their financial statements without calling in the original has resisted a stock split. Its shares by simply changing their par value. This type of “split” is really a large stock dividend recent stock price was and results in additional shares issued to stockholders by capitalizing retained earnings or trans- $170,000 per share. ferring other paid-in capital to Common Stock. This approach avoids administrative costs of Point: A reverse stock split splitting the stock. Harley-Davidson recently declared a 2-for-1 stock split executed in the form is the opposite of a stock split. of a 100% stock dividend. It increases both the market value per share and the par or stated value per share with a Decision Maker split ratio less than 1-for-1, such as 1-for-2. A reverse split Entrepreneur A company you co-founded and own stock in announces a 50% stock dividend. Has the value results in fewer shares. Markets of your stock investment increased, decreased, or remained the same? Would it make a difference if it was a often read bad news into reverse splits. 3-for-2 stock split executed in the form of a dividend? [Answers follow the chapter’s Summary.] NEED-TO-KNOW 13-2 A company began the current year with the following balances in its stockholders’ equity accounts. Recording Dividends Common stock — $10 par, 500 shares authorized, 200 shares issued and outstanding....................... $2,000 P2 Paid-in capital in excess of par, common stock............... 1,000 Retained earnings...................................... 5,000 Total................................................ $8,000 All outstanding common stock was issued for $15 per share when the company was created. Prepare jour- nal entries to account for the following transactions during the current year. Jan. 10 The board declared a $0.10 cash dividend per share to shareholders of record Jan. 28. Feb. 15 Paid the cash dividend declared on January 10. Mar. 31 Declared a 20% stock dividend. The market value of the stock is $18 per share. May 1 Distributed the stock dividend declared on March 31. Dec. 1 Declared a 40% stock dividend. The market value of the stock is $25 per share. Dec. 31 Distributed the stock dividend declared on December 1. Jan. 10 Retained Earningsa.............................. 20 Common Dividend Payable................... 20 Declared a $0.10 per share cash dividend. a 200 outstanding shares 3 $0.10 Feb. 15 Common Dividend Payable....................... 20 Cash..................................... 20 Paid $0.10 per share cash dividend. [continued on next page]  www.downloadslide.net Chapter 13 Accounting for Corporations 543 [continued from previous page] Mar. 31 Retained Earningsb.............................. 720 Common Stock Dividend Distributablec........ 400 Paid-In Capital in Excess of Par Value, Common Stock................. 320 Declared a small stock dividend of 20% or 40 shares; market value is $18 per share. b 200 outstanding shares 3 20% 3 $18 market c 40 new shares 3 $10 par May 1 Common Stock Dividend Distributable............. 400 Common Stock............................ 400 Distributed 40 shares of common stock. Dec. 1 Retained Earningsd.............................. 960 Common Stock Dividend Distributable......... 960 Declared a large stock dividend of 40% or 96 shares (40% 3 [200 1 40]); par value is $10 per share. d 240 outstanding shares 3 40% 3 $10 par Do More: QS 13-6, QS 13-7, QS 13-8, E 13-5, E 13-6 Dec. 31 Common Stock Dividend Distributable............. 960 Common Stock............................ 960 Distributed 96 shares of common stock. QC4 PREFERRED STOCK A corporation can issue two basic kinds of stock, common and preferred. Preferred stock has special rights that give it priority (or senior status) over common stock in one or more areas. C2 Explain characteristics of, Special rights typically include a preference for receiving dividends and for the distribution of and distribute dividends assets if the corporation is liquidated. Preferred stock carries all rights of common stock unless between, common and the corporate charter nullifies them. Most preferred stock, for instance, does not confer the right preferred stock. to vote. Exhibit 13.9 shows that preferred stock is issued by about one-fourth of corporations. All corporations is- EXHIBIT 13.9 sue common stock. (While rare, not all common stock Corporations and Preferred Stock carries voting rights; Google’s C Class common shares No Issued are nonvoting.) Preferred Preferred Stock 73% Stock 27% Issuance of Preferred Stock Preferred stock usually has a par value. Like common stock, it can be sold at a price different from par. Preferred stock is recorded in its own separate capital accounts. To illustrate, if Dillon Snow- boards issues 50 shares of $100 par value preferred stock for $6,000 cash on July 1, 2015, the entry is July 1 Cash......................................... 6,000 Assets 5 Liabilities 1 Equity Preferred Stock, $100 Par Value............... 5,000 16,000 15,000 11,000 Paid-In Capital in Excess of Par Value, Preferred Stock.......................... 1,000 $100 par value 3 50 shares Issued preferred stock for cash. $6,000 cash 2 [$100 par value 3 50 shares] The equity section of the year-end balance sheet for Dillon Snowboards, including preferred stock, is shown in Exhibit 13.10. (This exhibit assumes that common stock was issued at par.) Issuing no-par preferred stock is similar to issuing no-par common stock. Also, the entries for issuing preferred stock for noncash assets are similar to those for common stock.  www.downloadslide.net 544 Chapter 13 Accounting for Corporations EXHIBIT 13.10 Stockholders’ Equity Stockholders’ Equity with Common stock—$10 par value; 50,000 shares authorized; Common and Preferred 30,000 shares issued and outstanding............................... $300,000 Stock Preferred stock—$100 par value; 1,000 shares authorized; 50 shares issued and outstanding.............................. 5,000 Paid-in capital in excess of par value, preferred stock.............. 1,000 Retained earnings................................................. 65,000 Total stockholders’ equity.......................................... $371,000 Dividend Preference of Preferred Stock Preferred stock usually carries a preference for dividends, meaning that preferred stockholders are allocated their dividends before any dividends are allocated to common stockholders. The divi- dends allocated to preferred stockholders are usually expressed as a dollar amount per share or a percent applied to par value. A preference for dividends does not ensure dividends. If the directors do not declare a dividend, neither the preferred nor the common stockholders receive one. Cumulative or Noncumulative Dividend Most preferred stocks carry a cumulative divi- dend right. Cumulative preferred stock gives its owners a right to be paid both the current and Point: Dividend preference all prior periods’ unpaid dividends before any dividend is paid to common stockholders. When does not imply that preferred stockholders receive more divi- preferred stock is cumulative and the directors either do not declare a dividend to preferred stock- dends than common stockhold- holders or declare one that does not cover the total amount of cumulative dividend, the unpaid ers, nor does it guarantee a dividend amount is called dividend in arrears. Accumulation of dividends in arrears on cumula- dividend. tive preferred stock does not guarantee they will be paid. Noncumulative preferred stock con- fers no right to prior periods’ unpaid dividends if they were not declared in those prior periods. To illustrate the difference between cumulative and noncumulative preferred stock, assume that a corporation’s outstanding stock includes (1) 1,000 shares of $100 par, 9% preferred stock— yielding $9,000 per year (1,000 shares 3 $100 par 3 9%) in potential dividends, and (2) 4,000 shares of $50 par value common stock. During 2014, the first year of operations, the directors declare cash dividends of $5,000. In year 2015, they declare cash dividends of $42,000. See Ex- hibit 13.11 for the allocation of dividends for these two years. Allocation of year 2015 dividends depends on whether the preferred stock is noncumulative or cumulative. With noncumulative preferred, the preferred stockholders never receive the $4,000 skipped in 2014. If the preferred stock is cumulative, the $4,000 in arrears is paid in 2015 before any other dividends are paid. EXHIBIT 13.11 Preferred Common Allocation of Dividends (noncumulative vs. Preferred Stock Is Noncumulative cumulative preferred stock) Year 2014.................................... $ 5,000 $ 0 Year 2015 Step 1: Current year’s preferred dividend........ $ 9,000 Step 2: Remainder to common................. $33,000 Example: What dividends do Totals for 2014–2015........................... $14,000 $33,000 cumulative preferred stockhold- Preferred Stock Is Cumulative ers receive in 2015 if the cor- Year 2014.................................... $ 5,000 $ 0 poration paid only $2,000 of dividends in 2014? How does Year 2015 this affect dividends to com- Step 1: Dividend in arrears.................... $ 4,000 mon stockholders in 2015? Step 2: Current year’s preferred dividend........ 9,000 Answers: $16,000 ($7,000 divi- Step 3: Remainder to common................. $29,000 dends in arrears, plus $9,000 current preferred dividends). Totals for year 2015........................... $13,000 $29,000 Dividends to common stock- Totals for 2014–2015........................... $18,000 $29,000 holders decrease to $26,000. A liability for a dividend does not exist until the directors declare a dividend. If a preferred divi- dend date passes and the corporation’s board fails to declare the dividend on its cumulative preferred stock, the dividend in arrears is not a liability. The full disclosure principle requires a corporation to report (usually in a note) the amount of preferred dividends in arrears as of the balance sheet date. Participating or Nonparticipating Dividend Nonparticipating preferred stock has a feature that limits dividends to a maximum amount each year. This maximum is often stated as a percent of the stock’s par value or as a specific dollar amount per share. Once preferred  www.downloadslide.net Chapter 13 Accounting for Corporations 545 stockholders receive this amount, the common stockholders receive any and all additional divi- dends. Participating preferred stock has a feature allowing preferred stockholders to share with common stockholders in any dividends paid in excess of the percent or dollar amount stated on the preferred stock. This participation feature does not apply until common stockholders receive divi- dends equal to the preferred stock’s dividend percent. Many corporations are authorized to issue participating preferred stock but rarely do, and most managers never expect to issue it.2 Convertible Preferred Stock Preferred stock is more attractive to investors if it carries a right to exchange preferred shares for a fixed number of common shares. Convertible preferred stock gives holders the option to exchange their preferred shares for common shares at a specified rate. When a company pros- pers and its common stock increases in value, convertible preferred stockholders can share in this success by converting their preferred stock into more valuable common stock. Callable Preferred Stock Callable preferred stock gives the issuing corporation the right to purchase (retire) this stock from its holders at specified future prices and dates. The amount paid to call and retire a pre- Point: The issuing corpora- ferred share is its call price, or redemption value, and is set when the stock is issued. The call tion has the right, or option, to retire its callable preferred price normally includes the stock’s par value plus a premium giving holders additional return on stock. their investment. When the issuing corporation calls and retires a preferred stock, the terms of the agreement often require it to pay the call price and any dividends in arrears. IFRS Like U.S. GAAP, IFRS requires that preferred stocks be classified as debt or equity based on analysis of the stock’s contractual terms. However, IFRS uses different criteria for such classification. Reasons for Issuing Preferred Stock Corporations issue preferred stock for several reasons. One is to raise capital without sacrificing control. For example, suppose a company’s organizers have $100,000 cash to invest and orga- nize a corporation that needs $200,000 of capital to start. If they sell $200,000 worth of com- mon stock (with $100,000 to the organizers), they would have only 50% control and would need to negotiate extensively with other stockholders in making policy. However, if they issue $100,000 worth of common stock to themselves and sell outsiders $100,000 of 8%, cumulative preferred stock with no voting rights, they retain control. A second reason to issue preferred stock is to boost the return earned by common stockhold- ers. To illustrate, suppose a corporation’s organizers expect to earn an annual after-tax income of $24,000 on an investment of $200,000. If they sell and issue $200,000 worth of common stock, the $24,000 income produces a 12% return on the $200,000 of common stockholders’ equity. However, if they issue $100,000 of 8% preferred stock to outsiders and $100,000 of common stock to themselves, their own return increases to 16% per year, as shown in Exhibit 13.12. EXHIBIT 13.12 Net (after-tax) income.................................. $24,000 Return to Common Less preferred dividends at 8%........................... (8,000) Stockholders When Balance to common stockholders......................... $16,000 Preferred Stock Is Issued Return to common stockholders ($16,000y$100,000)........ 16% 2 Participating preferred stock is usually authorized as a defense against a possible corporate takeover by an “un- friendly” investor (or a group of investors) who intends to buy enough voting common stock to gain control. Taking a term from spy novels, the financial world refers to this type of plan as a poison pill that a company swallows if enemy investors threaten its capture. A poison pill usually works as follo