Corporations - Lecture 02 - Chapter 1 PDF

Accounting for Corporations Dr. Amr Hassan Lecture Notes Lecture (2)  Chapter 1 Corporations: Organization and Share Transactions Accounting for the Issuance of Shares: 1. Accounting for par value shares. 2. Accounting for Oversubscr...

Accounting for Corporations Dr. Amr Hassan Lecture Notes Lecture (2)  Chapter 1 Corporations: Organization and Share Transactions Accounting for the Issuance of Shares: 1. Accounting for par value shares. 2. Accounting for Oversubscription of Shares. 3. Accounting for the shares issued with other securities for a single price (lump-sum sales). 4. Accounting for shares issued for noncash consideration. 5. Accounting for share issue costs. 6. Accounting for start-up costs. 1- Accounting for par value shares: Example (1) ABC Corporation was incorporated on January 1, 2020 and is authorized to issue 200,000 common shares (CS) of $10 par value, and 20,000 preferred shares (PS) of 10%, $40 par value. On January 10, 2020, the company issued 40,000 common shares (CS) for cash at $10 per share, and 5,000 preferred shares (PS) for cash at $40 per share. Required: 1- Prepare the journal entries to record these transactions. 2- Show the effects these transactions on the financial statements on December, 31, 2020. Answer 1- The journal entries to record these transactions: No journal entry is required when the company received the authorization to issue the stock, because this event has no effect on either the company's assets or equity. Cash (40,000 x $10) 400,000 Common stock (CS) (Ordinary shares) 400,000 Cash (5,000 x $40) 200,000 Preferred stock (PS) (Preference Shares) 200,000 2- The effects these transactions on the financial statements: ABC Corporation Statement of financial position as at December, 31, 2020 (Extract) Assets Liabilities and Shareholders’ equity Shareholders’ equity: Common stock 400,000 Preferred stock 200,000 1 Example (2): Example continued Assume that ABC Corporation issues additional 10,000 of its common shares for cash at $15 per share and 2,000 of its preferred stock for cash at $50. Required: 1- Prepare the journal entries to record these transactions. 2- Prepare the shareholders’ equity section of ABC's statement of financial position to show the effect of the issuance of shares in examples (1) and (2). Answer 1. The journal entries: Cash (10,000 x $15) 150,000 Common stock (10,000 x $10) 100,000 Additional paid-in capital – common stock (10,000 x $5) 50,000 Cash (2,000 x $ 50) 100,000 Preferred stock (2,000 x $40) 80,000 Additional paid-in capital – preferred stock (2,000 x $10) 20,000 2. The shareholders’ equity section of ABC's statement of financial position (Extract): Common stock, $10 par value, 200,000 shares authorized, 50,000 500,000 shares issued and outstanding 10% preferred stock, $40 par value, 20,000 shares authorized, 280,000 7,000 shares issued and outstanding Additional paid-in capital – common stock 50,000 Additional paid-in capital – preferred stock 20,000 Total paid-in capital (contributed capital) 850,000 Note: “Paid-in capital in excess of par value” = “Additional paid-in capital” = “Share Premium” = “Issuing Premium” 2 2- Accounting for Oversubscription of Shares: “Oversubscribed of shares” is a term used when the demand for a new issue of shares is greater than the number of shares available, so the issuer can't fulfill the market demand. When a new issue is oversubscribed, underwriters (investment banking firm) should assign the oversubscribed of shares according to the number of shares available by the “Pro-rata allotment”. Pro-rata allotment means no applicant is rejected. However, they will not receive the desired number of shares. Everyone receives shares according to “the ratio of the total number of applicants / total number of shares issued”. For Example, ABC Company is planning to offer 40,000 shares to the public via IPO (Initial Public Offering). However, it receives 80,000 share applications. So, the shares available should allotted to every applicant by the ratio (80,000:40,000) or (2:1) and that’s means "ABC IPO oversubscribed 2 times". Because of that, every applicant for 2 shares will receive 1 share. Example (3): ABC Corporation was incorporated on November 1, 2020 and is authorized to issue 500,000 common shares of $10 par value and 100,000 preferred shares of $20 par value. On November 10, 2020, the company issued the following number of shares: o 100,000 common shares for cash at $10 per share, and the investors (stockholders) subscribe at 120,000 common shares. o 10,000 preferred shares for cash at $20 per share, and the investors (stockholders) subscribe at 15,000 preferred shares. On December 24, 2020, the company returned the oversubscription of shares only for 15,000 common shares and 2,000 preferred shares till the end of the year. Required: 1- Prepare the journal entries to record these transactions. 2- Show the effects these transactions on the financial statements on December, 31, 2020. 3  Answer 1- the journal entries to record these transactions: Cash (120,000 x $10) 1,200,000 November 10, Common stock 1,000,000 2020 Oversubscription – Common stock 200,000 Cash (15,000 x $20) 300,000 November 10, Preferred stock 200,000 2020 Oversubscription – Preferred stock 100,000 December 24, Oversubscription – Common stock (15,000 x $10) 150,000 2020 Cash 150,000 December 24, Oversubscription – Preferred stock (2,000 x $20) 40,000 2020 Cash 40,000 2- The effects these transactions on the financial statements: ABC Corporation Statement of financial position as at December, 31, 2020 (Extract) Assets Liabilities and Shareholders’ equity Shareholders’ equity: Common stock 1,000,000 Preferred stock 200,000 Liabilities: Oversubscription – Common stock 50,000 Oversubscription – Preferred stock 60,000 3- Accounting for the sale of multi-class of issued shares (securities) for a single price (Lump-Sum Sales) (Sales Packages): A corporation might sell more than one class of shares (common and preferred shares) for a single price (Lump-Sum Sales). The problem that faces companies is “how to allocate the proceeds from sales among the several classes of shares”. Two methods of allocation are available in accounting: (1) The proportional method, (2) The incremental method. 4 1- The proportional method: is used if the fair value of each class of shares is known, the company allocates the selling price received on a proportional basis using the fair value of each class of shares. Example (4) Assume that ABC Corporation issues 2,000 shares of $10 par value common shares having a fair value of $20 per share, and 2,000 share of $11 par value preferred shares having a fair value of $12 a share, for a single price of $60,000. Required: 1- Show how the corporation allocates the $60,000 among the two classes of securities. 2- Prepare the required journal entry to record this transaction. Answer 1- Allocation of the sale price among the two classes of securities: o Fair Value of securities: Fair value of common stock (2,000 x $20) $40,000 Fair value of preferred stock (2,000 x $12) $24,000 Total fair value $64,000 o Allocation of the selling price among the two classes of securities: Amount Allocated to common stock Common Stock = 2,000 x 10 = $20,000 40,000 $37,500 ( x 60,000) APIC – CS = remaining amount = $17,500 64,000 Amount Allocated to preferred stock Preferred stock = 2,000 x 11 = $22,000 24,000 $22,500 ( x 60,000) APIC – PS = remaining amount = $500 64,000 Total allocated amount (lump-sum sale) $60,000 $60,000 2- The journal entry: Cash 60,000 Common stock (2000 x $10) 20,000 Additional paid-in capital – common stock (37,500 – 20,000) 17,500 Preferred stock (2000 x $11) 22,000 Additional paid-in capital – preferred stock (22,500 – 22,000) 500 5 2- The incremental method: is used if the fair value of one class of shares is unknown, the company allocates the remaining amount of the lump sum to the class which the fair value is unknown. Example (5) Assume that ABC Company issues 10,000 shares of $10 par value common stock having a fair value of $18 a share and 10,000 share of $15 par value preferred stock having no established fair value for a single price of $500,000. Required: 1- Show how the company allocates the $500,000 among the two classes of securities. 2- Prepare the journal entry to record this transaction. Answer Allocation of the sale price among the two classes of securities: Amount Allocated to common stock Common Stock = 10,000 x 10 = $100,000 $ 180,000 (10,000 x $18) APIC – CS = remaining amount = $80,000 Amount Allocated to preferred stock Preferred stock = 10,000 x 15 = $150,000 $ 320,000 (remaining amount) APIC – PS = remaining amount = $170,000 Total allocated amount (lump-sum sale) $ 500,000 $ 500,000 The journal entry: Cash 500,000 Common stock (10,000 x $10) 100,000 Additional paid-in capital – common stock (180,000 – 100,000) 80,000 Preferred stock (10,000 x $15) 150,000 Additional paid-in capital – preferred stock (320,000 – 150,000) 170,000 6 4- Accounting for shares issued for non-cash consideration: Occasionally, a corporation might issue its stock for consideration other than cash such as: property, equipment, or any other noncash assets. In this case, corporations should record the shares issued for non-cash assets at “the fair value of these assets”. If the fair value of the non-cash assets cannot be measured reliably, “the fair value of the shares issued” is used. Example (6) Assume that ABC corporation issued 20,000 shares of $10 par value common stock for a building. If ABC cannot determine the fair value of the building, but the fair value per share is known to be $15. Answer The journal entry: Buildings 300,000 Common stock (20,000 x $10) 200,000 Additional paid-in capital – common stock (20,000 x $5) 100,000 Example (7) Assume that ABC corporation in Example (6) cannot determine the fair value of the shares, but it determines the fair value of the building is $350,000. Answer The journal entry: Buildings 350,000 Common stock (20,000 x $10) 200,000 Additional paid-in capital – common stock (remaining amount) 150,000 Example (8) Assume that ABC corporation in Example (6) is unable to determine neither the fair value of the shares nor the fair value of the building and that an independent consultant values the building at $325,000. Answer The journal entry: Buildings 325,000 Common stock (20,000 x $10) 200,000 Additional paid-in capital – common stock (remaining amount) 125,000 7 Example (9) Assume that the attorneys (lawyers) of the corporation agree to accept 5,000 shares of $1 par value common shares in the payment of their bill of $10,000 for legal services performed in the company incorporation. At the time of the exchange there is no established market value (fair value) for the shares. Required: Prepare a journal entry to record the above transaction. Answer Since there is no established market price for the stock, the market value of the service received is more clearly evident. The journal entry: Organization Expenses 10,000 Common stock (5,000 x $ 1) 5,000 Additional paid-in capital – common stock (remaining amount) 5,000 5- Accounting for share issue costs: When a company issues shares, it incurs direct costs such as: printing costs, underwriting costs, taxes, and accounting and legal fees. These costs reduce the net proceeds received from the sale of the shares (Cash). Share issue costs are not recorded as expense. These costs are recorded as a deduction from equity account of “additional paid in capital”. Example (10) On July 15, 2016, ABC Corporation issued 10,000 shares of its $20 par value common stock for cash at $28 per share. Legal fees and other direct costs of issuing the shares amounted to $10,000. Answer Cash (10,000 x $28 ― $10,000) 270,000 Common stock (10,000 x $20) 200,000 Ssss Additional paid-in capital – common stock (remaining amount) 70,000 8 6- Accounting for Start-up Costs: Start-up Costs: Startup costs are the initial expenditures and paid by the company’s founders needed to start a new business. These can include: Feasibility study costs: detailed analysis that considers all of the critical elements of a proposed project in order to determine its chances of success. Market research costs: Careful research of the industry and consumer behavior must be conducted before starting any business. Registration and license, and permit costs: Many businesses are required to obtain certain authorizations, licenses and permits. Advertising and promotion costs. Legal costs. The Egyptian Accounting Standard (EAS 23) “intangible assets” (paragraph 69) outlines examples of expenditure that would normally recognize as an expense when it is incurred include the Start-up costs which are consist of: establishment costs such as legal and secretarial costs incurred in establishing a legal entity, expenditure to open a new facility or business (i.e. pre-opening costs) or expenditures for starting new operations or launching new products or processes (i.e. pre-operating costs). Equity Issuance Fees: On another hand, the corporation may collect “Equity Issuance Fees” which is an amount imposed on each share sold to finance the start-up costs. For example: collect $1 on each share. The accounting treatment for Start-up Costs in case of collecting “Equity Issuance Fees” depends on the following situations: 1. If the Start-up Costs equals Equity Issuance Fees, the accounting treatment is recorded by offsetting the “Start-up Costs” account with the “Equity Issuance Fees” account. 2. If the Start-up Costs greater than Equity Issuance Fees, the difference (deficit) can be recorded as an expense in the income statement for the year. 3. If the Start-up Costs less than Equity Issuance Fees, the difference (surplus) is recorded by crediting to account of “additional paid-in capital”. 9 Example (11) On December 15, 2020 ABC Corporation issued 10,000 common shares of $20 par value for cash at $28 per share; equity issuance fees included $2 per share. Required: Prepare the journal entries to record these transactions and show the effects these transactions on the financial statements on December, 31, 2020, under the following assumptions: 1. Assumption (1): Start-up Costs amounted to $20,000. 2. Assumption (2): Start-up Costs amounted to $25,000. 3. Assumption (3): Start-up Costs amounted to $17,000. Answer 1. Assumption (1): Start-up Costs amounted to $20,000: The journal entries: Start-up Costs 20,000 Cash 20,000 Cash (10,000 x $28) 280,000 Common stock (10,000 x $20) 200,000 Equity Issuance Fees (10,000 x $2) 20,000 Additional paid-in capital – common stock 60,000 (remaining amount) (10,000 x $6) Equity Issuance Fees 20,000 Start-up Costs 20,000 The effects these transactions on the financial statements: ABC Corporation Statement of financial position as at December, 31, 2020 (Extract) Assets Liabilities and Shareholders’ equity Shareholders’ equity: Common stock (10,000 x $20) 200,000 Additional paid-in capital – Common stock (10,000 x $6) 60,000 Total Shareholders’ equity 260,000 ABC Corporation Income Statement for the year ended at December, 31, 2020 (Extract) Revenues & Expenses These transactions have no effect on the income statement. 10 2. Assumption (2): Start-up Costs amounted to $25,000: The journal entries: Start-up Costs 25,000 Cash 25,000 Cash (10,000 x $28) 280,000 Common stock (10,000 x $20) 200,000 Equity Issuance Fees (10,000 x $2) 20,000 Additional paid-in capital – common stock 60,000 (remaining amount) (10,000 x $6) Equity Issuance Fees 20,000 Start-up Costs 20,000 The effects these transactions on the financial statements: ABC Corporation Statement of financial position as at December, 31, 2020 (Extract) Assets Liabilities and Shareholders’ equity Shareholders’ equity: Common stock (10,000 x $20) 200,000 Additional paid-in capital – Common stock (10,000 x $6) 60,000 Total Shareholders’ equity 260,000 ABC Corporation Income Statement for the year ended at December, 31, 2020 (Extract) Revenues & Expenses Expenses: Start-up Costs 5,000 3. Assumption (3): Start-up Costs (Establishment Cost) amounted to $17,000: The journal entries: Start-up Costs 17,000 Cash 17,000 Cash (10,000 x $28) 280,000 Common stock (10,000 x $20) 200,000 Equity Issuance Fees (10,000 x $2) 20,000 Additional paid-in capital – common stock 60,000 (remaining amount) (10,000 x $6) Equity Issuance Fees 20,000 Start-up Costs 17,000 Additional paid-in capital – common stock 3,000 (remaining amount) 11  The effects these transactions on the financial statements: ABC Corporation Statement of financial position as at December, 31, 2020 (Extract) Assets Liabilities and Shareholders’ equity Shareholders’ equity: Common stock (10,000 x $20) 200,000 Additional paid-in capital – Common stock 63,000 (10,000 x $6) + 3,000 Total Shareholders’ equity 263,000 ABC Corporation Income Statement for the year ended at December, 31, 2020 (Extract) Revenues & Expenses These transactions have no effect on the income statement. 12