ch11 wrd12e instructor_final

Corporations:

Organization,

Stock Stock

Transactions,

and Dividends

Chapter 11Chapter 11Chapter 11Chapter 11

Learning ObjectivesLearning Objectives

1.1. Describe the nature of the corporate form Describe the nature of the corporate form of organization.of organization.

2.2. Describe the two main sources of Describe the two main sources of stockholders’ equity.stockholders’ equity.

3.3. Describe and illustrate the characteristics Describe and illustrate the characteristics of stock, classes of stock, and entries for of stock, classes of stock, and entries for issuing stock.issuing stock.

4.4. Describe and illustrate the accounting for Describe and illustrate the accounting for cash dividends and stock dividends.cash dividends and stock dividends.

5.5. Describe and illustrate the accounting for Describe and illustrate the accounting for treasury stock transactions.treasury stock transactions.

Learning ObjectivesLearning Objectives

6.6. Describe and illustrate the reporting of Describe and illustrate the reporting of stockholders’ equity.stockholders’ equity.

7.7. Describe the effect of stock splits on Describe the effect of stock splits on corporate financial statements.corporate financial statements.

8.8. Describe and illustrate the use of Describe and illustrate the use of earnings per share in evaluating a earnings per share in evaluating a company’s profitability.company’s profitability.

Learning Learning Objective

ObjectiveDescribe the nature of the

Describe the nature of the

corporate form of organization

Characteristics of a CorporationCharacteristics of a Corporation

o A A corporationcorporation is a legal entity, distinct and is a legal entity, distinct and separate from the individuals who create separate from the individuals who create and operate it. As a legal entity, a and operate it. As a legal entity, a corporation may acquire, own, and corporation may acquire, own, and dispose of property in its own name.dispose of property in its own name.

o A corporation sells shares of ownership, A corporation sells shares of ownership, called called stockstock..

o The The stockholdersstockholders or shareholders who own or shareholders who own the stock own the corporation. They can the stock own the corporation. They can buy and sell stock without affecting the buy and sell stock without affecting the corporation’s operations or continued corporation’s operations or continued existence.existence.

o Corporations whose shares of stock are Corporations whose shares of stock are traded in public markets are called traded in public markets are called publicpublic corporationscorporations..

o Corporations whose shares are not traded Corporations whose shares are not traded publicly are usually owned by a small publicly are usually owned by a small group of investors and are called group of investors and are called nonpublicnonpublic or or privateprivate corporationscorporations. The . The stockholders of all corporations have stockholders of all corporations have limitedlimited liabilityliability..

o The stockholders control a corporation by The stockholders control a corporation by electing a electing a board of directorsboard of directors. This board . This board meets periodically to establish corporate meets periodically to establish corporate policy. It also selects the chief executive policy. It also selects the chief executive officer (CEO) and other major officers.officer (CEO) and other major officers.

CHARACTERISTICHARACTERISTICS OF A CS OF A

CORPORATIONCORPORATION

o A corporation has separate legal existence A corporation has separate legal existence from its owners.from its owners.

o A corporation has transferable units of A corporation has transferable units of ownership.ownership.

o A corporation has limited stockholders’ A corporation has limited stockholders’ liability.liability.

o A corporation is subject to taxes. Thus, the A corporation is subject to taxes. Thus, the corporate form has the disadvantage of corporate form has the disadvantage of double taxationdouble taxation. .

(continued)

Forming a CorporationForming a Corporation

o The first step in forming a corporation is to The first step in forming a corporation is to file an file an application of incorporationapplication of incorporation with the with the state.state. Because state laws differ, corporations often Because state laws differ, corporations often

organize in states with more favorable laws.organize in states with more favorable laws.

More than half of the largest companies are More than half of the largest companies are incorporated in Delaware (see Exhibit 3, next incorporated in Delaware (see Exhibit 3, next

slideslide).).

FORMING A FORMING A CORPORATIONCORPORATION

o After the application is approved, the state After the application is approved, the state grants a grants a chartercharter or or articles of articles of incorporationincorporation,, which formally create the which formally create the corporation.corporation.

o Management and the board of directors Management and the board of directors then prepare then prepare bylawsbylaws which are operating which are operating rules and procedures for conducting the rules and procedures for conducting the corporation’s affairs.corporation’s affairs.

o Costs may be incurred in organizing a Costs may be incurred in organizing a corporation, such as legal fees, taxes, corporation, such as legal fees, taxes, license fees, and promotional costs. The license fees, and promotional costs. The recording of a corporation’s organizing recording of a corporation’s organizing costs of $8,500 on January 5 is shown costs of $8,500 on January 5 is shown below:below:

ObjectiveDescribe the two main sources

Describe the two main sources

of stockholders’ equity

Stockholders’ EquityStockholders’ Equity

o The owner’s equity in a corporation is The owner’s equity in a corporation is called called stockholders’ equitystockholders’ equity, , shareholders’ shareholders’ equityequity, , shareholders’ investmentshareholders’ investment, or , or capitalcapital..

o Stockholders’ equity Stockholders’ equity is reported by its two is reported by its two main sources.main sources. Capital contributed to Capital contributed to

the corporation by the the corporation by the stockholders, called stockholders, called paid-in capitalpaid-in capital or or contributed capital.contributed capital.

Net income retained Net income retained in the business, called in the business, called retained earningsretained earnings..

STOCKHOLDERSTOCKHOLDERS’ EQUITYS’ EQUITY

If there is only one class of stock, the account is entitled Common StockCommon Stock

or Capital StockCapital Stock.

o Retained earnings is a corporation’s Retained earnings is a corporation’s cumulative net income that has not been cumulative net income that has not been distributed as dividends.distributed as dividends.

o DividendsDividends are distributions of a are distributions of a corporation’s earnings to stockholders.corporation’s earnings to stockholders.

o A debit balance in Retained Earnings is A debit balance in Retained Earnings is called a called a deficitdeficit. Such a balance often . Such a balance often results from accumulated net losses. results from accumulated net losses.

o A credit balance in Retained Earnings does A credit balance in Retained Earnings does not represent surplus cash or cash left not represent surplus cash or cash left over for dividends.over for dividends.

ObjectiveDescribe and illustrate the

Describe and illustrate the

characteristics of stock, classes

of stock, and entries for issuing

of stock, and entries for issuing stockstock

Characteristics of StockCharacteristics of Stock

o The number of shares of stock that a The number of shares of stock that a corporation is corporation is authorized authorized to issue is stated to issue is stated in the charter.in the charter.

o The term The term issuedissued refers to the shares refers to the shares issued to the stockholders.issued to the stockholders.

o A corporation may reacquire some of the A corporation may reacquire some of the stock that has been issued. The stock stock that has been issued. The stock remaining in the hands of stockholders is remaining in the hands of stockholders is then called then called outstandingoutstanding stockstock..

CHARACTERISTICHARACTERISTICS OF STOCKCS OF STOCK

Outstanding

o Corporations may issue stock certificates Corporations may issue stock certificates to stockholders to document their to stockholders to document their ownership.ownership.

o Shares of stock are often assigned a dollar Shares of stock are often assigned a dollar amount, called amount, called parpar value. value.

o Some corporations have stopped issuing Some corporations have stopped issuing stock certificates except on special stock certificates except on special request.request.

o Stock issued without par is called Stock issued without par is called no-par no-par stockstock. Some states require the board of . Some states require the board of directors to assign a directors to assign a stated valuestated value to no- to no-par stock.par stock.

o Some state laws require that corporations Some state laws require that corporations maintain a minimum stockholder maintain a minimum stockholder contribution, called contribution, called legal capitallegal capital, to protect , to protect creditors.creditors.

o The major rights that accompany The major rights that accompany ownership of a share of stock are as ownership of a share of stock are as follows:follows: The right to vote in matters concerning the The right to vote in matters concerning the

corporation.corporation.

The right to share in distributions of earnings.The right to share in distributions of earnings.

The right to share in assets upon liquidation.The right to share in assets upon liquidation.

Classes of StockClasses of Stock

o The two primary classes of paid-in capital The two primary classes of paid-in capital are common stock and preferred stock.are common stock and preferred stock.

o The primary attractiveness ofThe primary attractiveness of preferred preferred stockstock is that it is given a preference to is that it is given a preference to dividends over common stock.dividends over common stock.

o The payment of dividends is authorized by The payment of dividends is authorized by the corporation’s board of directors.the corporation’s board of directors.

o When authorized, the directors are said to When authorized, the directors are said to have have declareddeclared a dividend. a dividend.

o Cumulative preferred stockCumulative preferred stock has a right to has a right to receive regular dividends that were not receive regular dividends that were not declared (paid) in prior years. declared (paid) in prior years. Noncumulative preferred stock does not have Noncumulative preferred stock does not have

this right.this right.

Cumulative preferred stock dividends that have Cumulative preferred stock dividends that have not been paid in prior years are said to be not been paid in prior years are said to be in in arrearsarrears..

(continued)

o A corporation has issued the following A corporation has issued the following preferred and common stock:preferred and common stock:1,000 shares of $4 cumulative preferred stock, 1,000 shares of $4 cumulative preferred stock, $50 par 4,000 shares of common stock, $15 par$50 par 4,000 shares of common stock, $15 par

o The corporation was organized on January The corporation was organized on January 1, 2012, and paid no dividends in 2012 1, 2012, and paid no dividends in 2012 and 2013. In 2014, the corporation paid and 2013. In 2014, the corporation paid $22,000 in dividends, of which $12,000 $22,000 in dividends, of which $12,000 was paid to preferred stockholders and was paid to preferred stockholders and $10,000 was paid to common $10,000 was paid to common stockholders.stockholders.

The 2012 dividends in arrears are paid first. There are 1,000 shares, and each share

receives $4 for a total of $4,000.

(continued)

The 2013 dividends in arrears are paid next. Again, the preferred stockholders receive $4 for each share held.

(continued)

The current dividends for 2014 must be paid to preferred stockholders before common stockholders

can participate in the dividends.

(continued)

Of the $22,000 in dividends declared, preferred must receive $12,000 before common can receive

any dividends.

(continued)

Dividends available to common stockholders

Issuing StockIssuing Stock

o A corporation is authorized to issue 10,000 A corporation is authorized to issue 10,000 shares of preferred stock, $100 par, and shares of preferred stock, $100 par, and 100,000 shares of common stock, $20 par. 100,000 shares of common stock, $20 par. One-half of each class of authorized One-half of each class of authorized shares is issued at par for cash.shares is issued at par for cash.

Issuing StockIssuing Stock

o If the stock is issued (sold) for a price that If the stock is issued (sold) for a price that is more than its par, the stock has been is more than its par, the stock has been sold at a sold at a premiumpremium. .

o If the stock is issued (sold) for a price that If the stock is issued (sold) for a price that is less than its par, the stock has been is less than its par, the stock has been sold at a sold at a discountdiscount..

Premium on StockPremium on Stock

o Caldwell Company issues 2,000 shares of Caldwell Company issues 2,000 shares of $50 par preferred stock for cash at $55.$50 par preferred stock for cash at $55.

Premium on StockPremium on Stock

o A corporation acquired land for which the A corporation acquired land for which the fair market value cannot be determined. In fair market value cannot be determined. In exchange for the land, the corporation exchange for the land, the corporation issued 10,000 shares of $10 par common issued 10,000 shares of $10 par common that had a current market value of $12.that had a current market value of $12.

No-Par StockNo-Par Stock

o On January 9, a corporation issues 10,000 On January 9, a corporation issues 10,000 shares of no-par common stock at $40 a shares of no-par common stock at $40 a share. On June 27, the corporation issues share. On June 27, the corporation issues an additional 1,000 shares at $36.an additional 1,000 shares at $36.

o Some states require that the entire Some states require that the entire proceeds from the issue of no-par stock be proceeds from the issue of no-par stock be recorded as legal capital. In other states, recorded as legal capital. In other states, no-par stock may be assigned a no-par stock may be assigned a stated stated value per share.value per share.

o Using the same data as in the previous Using the same data as in the previous transaction, assume that the stock is transaction, assume that the stock is assigned a stated value of $25. assigned a stated value of $25.

accounting for cash dividends

accounting for cash dividends and stock dividends

and stock dividends

Cash DividendsCash Dividends

o A cash distribution of earnings by a A cash distribution of earnings by a corporation to its stockholders is called a corporation to its stockholders is called a cash dividendcash dividend. The three conditions a . The three conditions a corporation must meet to pay a cash corporation must meet to pay a cash dividend are as follows:dividend are as follows: Sufficient retained earningsSufficient retained earnings

Sufficient cashSufficient cash

Formal action by the board of directorsFormal action by the board of directors

o The The date of declarationdate of declaration is the date the is the date the board of directors formally authorizes the board of directors formally authorizes the payment of the dividend. On this date, the payment of the dividend. On this date, the corporation incurs the liability to pay the corporation incurs the liability to pay the amount of the dividend.amount of the dividend.

o The The date of recorddate of record is the date the is the date the corporation uses to determine which corporation uses to determine which stockholders will receive the dividend. stockholders will receive the dividend.

o The The date of paymentdate of payment is the date the is the date the corporation will pay the dividends to the corporation will pay the dividends to the stockholders who owned the stock on the stockholders who owned the stock on the date of record.date of record.

o On October 1, Hiber Corporation declares On October 1, Hiber Corporation declares the cash dividends shown below with a the cash dividends shown below with a date of record of November 10 and a date date of record of November 10 and a date of payment of December 2.of payment of December 2.

o On October 1, the On October 1, the declaration datedeclaration date, Hiber , Hiber Corporation records the following entry:Corporation records the following entry:

o On November 10, the On November 10, the date of recorddate of record, no , no entry is required, since this date merely entry is required, since this date merely determines which stockholders will receive determines which stockholders will receive the dividends.the dividends.

o On December 2, the date of payment, On December 2, the date of payment, Hiber Corporation records the payment of Hiber Corporation records the payment of the dividends as follows:the dividends as follows:

Stock DividendsStock Dividends

o A distribution of dividends to stockholders A distribution of dividends to stockholders in the form of the firm’s own shares is in the form of the firm’s own shares is called a called a stock dividendstock dividend. Stock dividends . Stock dividends normally are declared only on common normally are declared only on common stock and issued to common stockholders.stock and issued to common stockholders.

o On December 15, the board of directors of On December 15, the board of directors of Hendrix Corporation declares a 5 percent Hendrix Corporation declares a 5 percent stock dividend of 100,000 shares stock dividend of 100,000 shares (2,000,000 shares × 5%) to be issued on (2,000,000 shares × 5%) to be issued on January 10 to stockholders of record on January 10 to stockholders of record on December 31. The market price on the December 31. The market price on the declaration date is $31 per share.declaration date is $31 per share.

o The entry to record the declaration of the The entry to record the declaration of the 5 percent stock dividend is as follows:5 percent stock dividend is as follows:

o At the end of the period, the stock At the end of the period, the stock dividends distributable and paid-in capital dividends distributable and paid-in capital in excess of par—common stock accounts in excess of par—common stock accounts are reported in the Paid-In Capital section are reported in the Paid-In Capital section of the balance sheet. Thus, the effect of of the balance sheet. Thus, the effect of the preceding stock dividend is to transfer the preceding stock dividend is to transfer $3,100,000 of retained earnings to paid-in $3,100,000 of retained earnings to paid-in capital.capital.

o On January 10, the stock dividend is On January 10, the stock dividend is distributed to stockholders by issuing distributed to stockholders by issuing 100,000 shares of common stock. The 100,000 shares of common stock. The following entry records the issue of the following entry records the issue of the stock:stock:

10,000 + (10,000 x 6%)

Total shares issued 10,000 10,600

Before Stock Dividend

After 6% Stock Dividend

o Before and After Stock Dividend Before and After Stock Dividend DistributionDistribution

Total shares issued 10,000 10,600Number of shares owned by one stockholder 1,000 1,060

1,000 + (1,000 x 6%)

Total shares issued 10,000 10,600Number of shares owned by one stockholder 1,000 1,060Proportionate ownership 10% 10%

1,000 ÷ 10,000 1,060 ÷ 10,600

accounting for treasury stock

accounting for treasury stock transactions

transactions

Treasury Stock TransactionsTreasury Stock Transactions

o Treasury stockTreasury stock is stock that a corporation is stock that a corporation has issued and then reacquired. A has issued and then reacquired. A corporation may purchase its own stock corporation may purchase its own stock for a variety of reasons, including the for a variety of reasons, including the following:following: To provide shares for resale to employeesTo provide shares for resale to employees

To reissue as bonuses to employees, To reissue as bonuses to employees, oror

To support the market price of the stockTo support the market price of the stock

o On February 13, a firm purchased 1,000 On February 13, a firm purchased 1,000 shares of treasury stock (common stock, shares of treasury stock (common stock, $25 par) at $45 per share. The cost $25 par) at $45 per share. The cost method for accounting for treasury stock method for accounting for treasury stock is used. The entry to record the purchase is used. The entry to record the purchase of the treasury stock is as follows:of the treasury stock is as follows:

o On April 29, the corporation sells 600 On April 29, the corporation sells 600 shares of the treasury stock for $60. The shares of the treasury stock for $60. The entry to record the sale is as follows:entry to record the sale is as follows:

The amount (per share) debited to Treasury Stock when purchased is the amount per share that must be credited to that account when sold (600 x $45).

o On October 4, the corporation sells the On October 4, the corporation sells the remaining 400 shares of treasury stock for remaining 400 shares of treasury stock for $40 per share. The entry to record the sale $40 per share. The entry to record the sale is as follows:is as follows:

reporting of stockholders’ equity

Reporting Stockholders’ EquityReporting Stockholders’ Equity

o Exhibit 4 Exhibit 4 shows two methods for reporting shows two methods for reporting stockholders’ equity for the December 31, stockholders’ equity for the December 31, 2014, balance sheet of Telex Inc.2014, balance sheet of Telex Inc.

o In the first method, shown in the In the first method, shown in the next next slideslide, each class of stock is reported, , each class of stock is reported, followed by its related paid-in capital followed by its related paid-in capital accounts. Retained earnings is then accounts. Retained earnings is then reported, followed by a deduction for reported, followed by a deduction for treasury stock.treasury stock.

(continued)

REPORTING REPORTING STOCKHOLDERSTOCKHOLDER

S’ EQUITYS’ EQUITY

Reporting Stockholders’ EquityReporting Stockholders’ Equity

o In the second method, the stock accounts In the second method, the stock accounts are reported, followed by the paid-in are reported, followed by the paid-in capital reported as a single item, capital reported as a single item, Additional paid-in capital. Retained Additional paid-in capital. Retained earnings is then reported, followed by a earnings is then reported, followed by a deduction for treasury stock. Method 2 is deduction for treasury stock. Method 2 is shown on the shown on the next slidenext slide..

(concluded)

REPORTING REPORTING STOCKHOLDERSTOCKHOLDER

Reporting Retained EarningsReporting Retained Earnings

o Changes to retained earnings may be Changes to retained earnings may be reported using one of the following:reported using one of the following: Separate retained earnings statementSeparate retained earnings statement

Combined income and retained earnings Combined income and retained earnings statementstatement

Statement of stockholders’ equityStatement of stockholders’ equity

REPORTING REPORTING RETAINING RETAINING EARNINGSEARNINGS

When a separate retained earnings retained earnings statementstatement iis prepared, the beginning balance of retained earnings is reported.

RestrictionsRestrictions

o The retained earnings available for use as The retained earnings available for use as dividends may be restricted by action of a dividends may be restricted by action of a corporation’s board of directors. corporation’s board of directors.

o These amounts, called These amounts, called restrictionsrestrictions or or appropriationsappropriations, remain part of the retained , remain part of the retained earnings. However, they must be earnings. However, they must be disclosed, usually in the notes to the disclosed, usually in the notes to the financial statements.financial statements.

RestrictionsRestrictions

o Restrictions of retained earnings are Restrictions of retained earnings are classified as follows:classified as follows: Legal:Legal: State laws may require a restriction of State laws may require a restriction of

retained earnings.retained earnings.

Contractual:Contractual: A corporation may enter into A corporation may enter into contracts that require restrictions of retained contracts that require restrictions of retained earnings.earnings.

Discretionary:Discretionary: A corporation’s board of A corporation’s board of directors may restrict retained earnings directors may restrict retained earnings voluntarily.voluntarily.

Prior Period AdjustmentsPrior Period Adjustments

o Errors may not be discovered within the Errors may not be discovered within the same period in which they occur. The same period in which they occur. The correction of this type of error, called a correction of this type of error, called a prior periodprior period adjustmentadjustment, is reported in the , is reported in the retained earnings statement as an retained earnings statement as an adjustment to the beginning balance of adjustment to the beginning balance of retained earnings.retained earnings.

Statement of Stockholders’ EquityStatement of Stockholders’ Equity

o When the only change to stockholders’ When the only change to stockholders’ equity is due to net income or net loss and equity is due to net income or net loss and dividends, a retained earnings statement dividends, a retained earnings statement is sufficient.is sufficient.

o When a corporation also has changes in When a corporation also has changes in stock and paid-in capital accounts, a stock and paid-in capital accounts, a statement of stockholders’ equitystatement of stockholders’ equity is is normally prepared.normally prepared.

STATEMENT OF STATEMENT OF STOCKHOLDERSTOCKHOLDER

MORNIN’ JOE’S STATEMENTSMORNIN’ JOE’S STATEMENTS

Mornin’ Joe’s retained earnings statement for the Mornin’ Joe’s retained earnings statement for the year ended December 31, 2014, is as follows:year ended December 31, 2014, is as follows:

MORNIN’ JOE’S STATEMENTSMORNIN’ JOE’S STATEMENTS

The statement of stockholders’ equity for The statement of stockholders’ equity for Mornin’ Joe is shown below:Mornin’ Joe is shown below:

ObjectiveDescribe the effect of stock

Describe the effect of stock

splits on corporate financial

splits on corporate financial statementsstatements

Stock SplitsStock Splits

o A A stock splitstock split is a process by which a is a process by which a corporation reduces the par or stated corporation reduces the par or stated value of its common stock and issues a value of its common stock and issues a proportionate number of additional shares.proportionate number of additional shares.

Stock SplitsStock Splits

o Rojek Corporation has 10,000 shares of Rojek Corporation has 10,000 shares of $100 par common stock outstanding with $100 par common stock outstanding with a current market price of $150 per share. a current market price of $150 per share. The board of directors declares the The board of directors declares the following stock split:following stock split: Each common shareholder will receive 5 shares Each common shareholder will receive 5 shares

for each share held.for each share held.

The par of each share of common stock will be The par of each share of common stock will be reduced to $20 ($100/5).reduced to $20 ($100/5).

STOCK SPLITSSTOCK SPLITS

ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

earnings per share in evaluating

a company’s profitability

Earnings per ShareEarnings per Share

o Earnings per common share (EPS)Earnings per common share (EPS), , sometimes called basic earnings per sometimes called basic earnings per share, is the net income per share of share, is the net income per share of common stock outstanding during a common stock outstanding during a period.period.

o Earnings per share is computed as follows:Earnings per share is computed as follows:

Earnings per ShareEarnings per Share =Net Income – Preferred Dividends

Average Number of Common Shares Outstanding

EARNINGS PER EARNINGS PER SHARESHARE

Corporations:

Organization,

Stock Stock

Transactions,

and Dividends

The EndThe EndThe EndThe End

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