accounting for companies

13-1

© The McGraw-Hill Companies, Inc., 2006

Accounting for Corporations

13-2


Shas Production

Follow us on Facebook

13-3


Learning objectives

Identify characteristics of corporations and their organization. Describe the components of stockholders’ equity. Explain characteristics of common and preferred stock. Explain the form and content of a complete income statement. Explain the items reported in retained earnings. Record the issuance of corporate stock. Distribute dividends between common stock and preferred stock. Record transactions involving cash dividends. Account for stock dividends and stock splits. Record purchases and sales of treasury stock and the retirement of

stock.

13-4


Privately HeldPrivately Held

Publicly HeldPublicly Held

Ownership can be

Corporate Form of Organization

Existence is separate from

owners.

An entity created by law.

Has rights and privileges.

13-5


Characteristics of CorporationsAdvantages

Separate Legal Entity Limited Liability of Stockholders Transferable Ownership Rights Continuous Life Stockholders Are Not Corporate Agents Ease of Capital Accumulation

Disadvantages Governmental Regulation Corporate Taxation

13-6


StockholdersStockholders

Board of DirectorsBoard of Directors

President, Vice-President, President, Vice-President, and Other Officersand Other Officers

Employees of the CorporationEmployees of the Corporation

Organizing and Managing a Corporation

13-7


C orpora te O rgan iza tion C hart

Secretary V ice P residentF inance

V ice PresidentP roduction

V ice P residentMarketing

President

Board of D irectors

S tockho ldersUltimate Ultimate control.control.

Stockholders Stockholders usually meet usually meet once a year.once a year.

Organizing and Managing a Corporation

Selected by a Selected by a vote of the vote of the

stockholders.stockholders.

Overall Overall responsibility responsibility for managing for managing the company.the company.

13-8


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.

13-9


Each unit of ownership is called a share of stock.A stock certificate serves as proof that a

stockholder has purchased shares.

Stock Certificates and Transfer

When the stock is sold, the stockholder signs a transfer endorsement on the back of the stock

certificate.

13-10


Basics of Capital Stock

Total amount of stock that a Total amount of stock that a corporation’s charter authorizes it to sell.corporation’s charter authorizes it to sell.

13-11


Basics of Capital Stock

Total amount of stock that has been Total amount of stock that has been issued to stockholders.issued to stockholders.

13-12


Par valuePar value is an is an arbitrary amount arbitrary amount assigned to each assigned to each

share of stock when share of stock when it is authorized.it is authorized.

Market price Market price is the is the amount that each amount that each share of stock will share of stock will

sell for in the market.sell for in the market.

Selling (Issuing) Stock

13-13


Par Value StockOn September 1, Matrix, Inc. issued 100,000

shares of $2 par value stock for $25 per share. Let’s record this transaction.

Record:1. The cash received.2. The number of shares issued × the par value

per share in the Common Stock account.3. The remainder is assigned to Contributed

Capital in Excess of Par.

Issuing Par Value Stock

13-14




shares of $2 par value stock for $25 per share. Let’s record this transaction.

Sept. 1 Cash 2,500,000 Common stock, $2 par value 200,000

Contributed capital in excess of par value 2,300,000

Sold and issued 100,000 shares of common stock

13-15



13-16


Record:1. The asset received at its market value.2. The number of shares issued × the par value

per share in the Common Stock account.3. The remainder is assigned to Contributed

Capital in Excess of Par.

Issuing Stock for Noncash Assets


shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction.

13-17


Issuing Stock for Noncash Assets

Sept. 1 Land 2,500,000 Common stock, $2 par value 200,000

Contributed capital in excess of par value 2,300,000

Exchanges 100,000 common shares for land


shares of $2 par value stock for land valued at $2,500,000. Let’s record this transaction.

13-18


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 dividend rate.

Normally has no voting rights.

13-19


Preferred Stock

Dillon Snowboards issues 50 shares of $100 par value preferred stock for $6,000 cash on July 1, 2005.

Dr. Cash 6,000

Cr. Preferred Stock, $100 par value 5,000

Cr. Contributed Capital in Excess

of par value, preferred stock 1,000

13-20


Reasons for Issuing Preferred Stock

To raise capital without sacrificing control.

To appeal to investors who may believe the common stock is too risky or that the expected return on common stock is too low.

13-21


Cash Dividends

To pay a cash dividend the corporation

must have:1. A sufficient balance

in retained earnings and

2. The cash necessary to pay the dividend.

Cash Dividend Types and Frequency

73%

23%

0%

20%

40%

60%

80%

100%

Common Preferred

13-22


Cash DividendsRegular cash dividends provide a return to investors and almost always

affect the stock’s market value.

Dividends

Stockholders

June30

Corporation

13-23


Entries for Cash Dividends

Three important datesThree important dates

Date of DeclarationRecord liability

for dividend.

Dividends

Date of RecordNo entryrequired.

Date of PaymentRecord payment of

cash to stockholders.

13-24


Date of DeclarationRecord liability

for dividend.

Dividends


OnOn January 19, a $1 per share cash dividend is January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be shares outstanding. The dividend will be

paid on March 19 to stockholders of record paid on March 19 to stockholders of record on February 19.on February 19.

Jan. 19 Retained earnings 10,000 Common dividend payable 10,000

Declared $1 per share cash dividend

13-25


Date of RecordNo entryrequired.


On January 19, a $1 per share cash dividend is On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be shares outstanding. The dividend will be


No entry required on February 19.

13-26


Date of PaymentRecord payment of

cash to stockholders.


On January 19, a $1 per share cash dividend is On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s 10,000 common declared on Dana, Inc.’s 10,000 common shares outstanding. The dividend will be shares outstanding. The dividend will be


Mar. 19 Common dividend payable 10,000 Cash 10,000

Paid $1 per share cash dividend

13-27


Deficits and Cash DividendsCreated when a company incurs cumulative losses or pays

dividends greater than total profits earned in other years.

13-28


Stock Dividends

The corporation distributes additional shares of its own stock to its stockholders without receiving any

payment in return.

Stockholders

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.

100 Shares

$1 par value

HotAir, Inc.Common Stock

100 shares

$1 par

13-29


Stock Dividends

A company has 1,000 common shares outstanding. Market price is $12. The company announces a 20% stock dividend. The market price will be $10. However, due to the expectation of future more cash dividend, the market price may increase to 10.5 or so.

13-30


Stock DividendsSmall Stock Dividend

Distribution is 25% of the previously outstanding shares.

Capitalize retained earnings for the market value of the shares to be distributed.

Large Stock DividendDistribution is > 25% of the previously

outstanding shares.Capitalize retained earnings for the minimum

amount required by state law, usually par or stated value of the shares.

13-31


Recording a Small Stock DividendHere is the stockholders’ equity section of

Quest’s balance sheet prior to the declaration of a small stock dividend.

13-32


Recording a Small Stock DividendOn December 31, 2005, Quest declared a 2% stock

dividend, when the stock was selling for $10 per share. The stock will be distributed to stockholders on

January 20, 2006. Let’s make the December 31 entry.

100,000 × 2% = 2,000 × $10 = $20,000/ 100,000 × 2% = 2,000 × $10 = $20,000/ 10000*.02=2000shares10000*.02=2000shares

2,000 × $1 par = $2,000 × $1 par = $2,000/2000*$10=20000RE, 2000*$1=20002,000/2000*$10=20000RE, 2000*$1=2000

Dec. 31 Retained earnings 20,000 Common stock dividend distributable 2,000 Contributed capital in excess of par value 18,000

Declared a 2,000 shares (2%) stock dividend

13-33


Before theBefore thestockstock

dividend.dividend.

After theAfter thestockstock

dividend.dividend.

13-34


Recording a Large Stock DividendRouter, Inc. shows the following stockholders’

equity section just prior to issuing a large stock dividend.

13-35


Recording a Large Stock DividendOn December 31, 2005, Router declared a 40% stock

dividend, when the stock was selling for $8 per share. State law requires that large stock

dividends be capitalized at par value per share.

50,000 × 40% = 20,000 shares × $1 par value = $20,00050,000 × 40% = 20,000 shares × $1 par value = $20,000

Dec. 31 Retained earnings 20,000 Common stock dividend distributable 20,000

Declared a 20,000 shares (40%) stock dividend

13-36


Stock SplitsA distribution of additional shares of stock to stockholders

according to their percent ownership.

Common Stock

$10 par value

100 shares

OldShares

NewShares Common Stock

$5 par value

200 shares

13-37


Stock Splits

Thomas, Inc. has the following stockholders’ equity Thomas, Inc. has the following stockholders’ equity section just prior to a 2-for-1 stock split.section just prior to a 2-for-1 stock split.

13-38


Stock Splits

After the 2-for-1 split the stockholders’ equity section of After the 2-for-1 split the stockholders’ equity section of the balance sheet looks like this . . .the balance sheet looks like this . . .

No accountingentry is made.

13-39


Stock Splits

The split does not affect any equity amounts reported on balance sheet or any individual stockholder’s percent ownership. Both the contributed capital and retained earnings accounts are unchanged by a split.

13-40


Treasury StockCorporations acquire shares of their own stock.

Why would acompany do

that?

Use the shares to acquireUse the shares to acquirecontrol of another corporation.control of another corporation.

To avoid a hostile takeover.To avoid a hostile takeover.

Use the shares forUse the shares foremployee stock options.employee stock options.

To maintain a strong market forTo maintain a strong market forits stock or show managementits stock or show managementconfidence in the current price.confidence in the current price.

13-41


Treasury Stock

13-42


Purchasing Treasury Stock

On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000.

Treasury stock is shown as a reduction in totalTreasury stock is shown as a reduction in totalstockholders’ equity on the balance sheet.stockholders’ equity on the balance sheet.

May 8 Treasury stock, common 8,000 Cash 8,000

Purchase 2,000 treasury shares at $4 per share

13-43


Selling Treasury Stock at CostOn June 30, Whitt sold 100 shares of its treasury stock for $4 per share.

$8,000 ÷ 2,000 shares = $4 cost per treasury share

June 30 Cash 400 Treasury stock, common 400

Sold 100 shares of treasury for $4 per share

13-44


Selling Treasury Stock Above CostOn July 19, Whitt, Inc. sold an additional 500 shares

of its treasury stock for $8 per share.

July 19 Cash 4,000 Treasury stock, 2,000 Contributed capital, treasury stock 2,000

Sold 500 treasury shares for $8 per share

13-45


Selling Treasury Stock Below CostOn August 27, Whitt sold an additional 400 shares of its

treasury stock for $1.50 per share.

Aug. 27 Cash 600

1,000 Treasury stock, 1,600

Sold 500 treasury shares for $1.50 per share

Contributed capital, treasury stock

13-46


Net IncomeNet Income

Reporting Income and Equity

DiscontinuedSegments

Changes inAccounting

Principle

ExtraordinaryItems

ContinuingOperations

13-47


Revenues, expensesRevenues, expensesand income generatedand income generated

by the company’sby the company’scontinuing operations.continuing operations.

Continuing Operations

Net IncomeNet IncomeContinuingOperations

13-48


Income from operating the discontinued segment prior Income from operating the discontinued segment prior to its disposal to its disposal andand gain or loss on the sale of the net gain or loss on the sale of the net

assets of the segment.assets of the segment.

Discontinued Segments


DiscontinuedSegments

13-49


A gain or loss thatA gain or loss thatis is unusualunusual in nature in nature

and and infrequentinfrequent in inoccurrence.occurrence.

Extraordinary Items


ExtraordinaryItems

13-50


The increase or The increase or decrease in income decrease in income when changing fromwhen changing from

one generally acceptedone generally acceptedaccounting principle to accounting principle to

another.another.

Changes in Accounting Principles


Changes inAccounting

Principle

13-51


Income Statement

13-52


Earnings Per Share

Earnings per share is one of the most widely cited items of accounting information.

Basicearningsper share

= Net income - Preferred dividends Weighted-average common shares outstanding

13-53


Changes in Shares Outstanding

Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2005. The company started the year with 10,000 shares of

common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury shares on September 30, 2005.

13-54


EPS = EPS = $75,000 - $10,000 $75,000 - $10,000 12,50012,500 = = $5.20$5.20

Changes in Shares Outstanding

Derby, Inc. reports net income of $75,000 and paid preferred dividends of $10,000 during 2005. The company started the year with 10,000 shares of

common stock outstanding. Derby sold an additional 4,000 share of stock on March 31, and purchased 2,000 treasury shares on September 30, 2005.

13-55


Stock OptionsThe 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.

Optionpurchaseprice $30 per share.

Marketprice of

stock $75 per share.

13-56


Stock Options

Options are given to key employees to motivate them to:

focus on company performance,take a long-run perspective, andremain with the company.

13-57


13-58


Statement of Retained EarningsTotal cumulative amount of reported net income less

any net losses and dividends declared since the company started operating.

13-59


Legal Contractual

Most states restrictthe amount oftreasury stock

purchases to theamount of retained

earnings.

Loan agreementscan include

restrictions on paying

dividends below acertain amount ofretained earnings.

Restricted Retained Earnings

13-60


Appropriated Retained EarningsA corporation’s directors can voluntarily limit dividends

because of a special need for cash such as the purchase of new facilities.

13-61


Prior Period AdjustmentsCorrection of material errors in past years’ financial statements. If an amount is incorrectly expensed, add

amount to Retained Earnings.

13-62


(In millions) Retained Shares Amount Earnings Total

Balance at January 1, 2005 821 2,500$ 9,500$ 12,000$ Stock sales 17 500 500 Stock repurchases and retirement (17) (260) (925) (1,185) Cash dividends declared (150) (150) Other, net 70 70 Net income 5,100 5,100 Balance at December 31, 2005 821 2,740$ 13,595$ 16,335$

Common stock and capital in excess of par

Matrix, Inc.Statement of Stockholders' Equity

For the Year Ended December 31, 2005

Statement of Stockholders’ Equity

This is a more inclusive statement than the statement of retained earnings.

13-63


Book Value per Share—CommonRecords amount of stockholders’ equity applicable to common shares on

a per share basis.

Book value per Book value per common sharecommon share ==

Stockholders’ equity applicable to common shares

Number of common shares outstanding

13-64


Book Value per Share—PreferredRecords amount of stockholders’ equity applicable to preferred shares on

a per share basis.

Book value per Book value per preferredpreferred share share ==

Stockholders’ equity applicable to preferred shares

Number of preferred shares outstanding

13-65


Dividend Yield

Tells us the annual amount of cash dividends distributed to common stockholders relative to the stock’s

market price.

DividendDividendYieldYield == Annual cash dividends per share Annual cash dividends per share

Market value per shareMarket value per share

13-66


This ratio reveals information about the stock market’s This ratio reveals information about the stock market’s expectations for a company’s future growth in expectations for a company’s future growth in

earnings, dividends, and opportunities.earnings, dividends, and opportunities.

If earnings go up,will the market priceof my stock follow?

Price Earnings

Price-Price-EarningsEarnings ==

Market value per shareMarket value per share Earnings per shareEarnings per share

13-67


Homework for Chapter 13

Ex 13-16, 13-17 Problem 13-2A, 13-4A Due on July 12, 2006 (Wednesday)

13-68


End of Chapter

accounting for companies

Education