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Corporations: Paid-in Capital and the Balance Sheet
Chapter 12
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Advantages and Disadvantages of Corporations
ADVANTAGES1. Corporations can raise
more money2. Corporations have
continuous life3. Ownership transfer is
easy4. No mutual agency5. Stockholders have
limited liability
DISADVANTAGES1. Ownership and
management separated.2. Double taxation3. Government regulation
is expensive4. Start-up costs are higher
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Corporate OrganizationAuthorization–State’s permission to operateAuthorized stock–How many shares of a class of stock a corporation may issueCapital stock–Represents ownership of the corporation's capitalStock certificate–Paper evidencing ownership in a corporation
Company nameStockholder nameNumber of shares owned
Outstanding stock–Stock held by stockholders
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Stock
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Stockholders’ Equity BasicsPaid-in capital(Contributed capital)
Amounts received from stockholdersCommon stock is main sourceExternally generatedResulting from transactions with outsiders
Retained earningsEarned by profitable operationsInternally generated Results from internal corporate decisions to retain net income for use in the company
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Classes of StockCommon stock
Four basic rightsVote—voting on corporate mattersDividends—receive a proportionate part of dividend declared Liquidation—receive a proportionate part of assets remainingPreemption—maintain their proportionate ownership
Preferred stockCertain advantages over common stock
Receive dividends before commonFixed dividend amountUpon liquidation, receive assets before commonAlso have basic rights of common stockholders unless withheld
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Par, Stated and No-par
Par valueArbitrary amount assigned to a share of stockSet when the corporate charter is filedUsually set low as to avoid legal difficulties
No-parNo arbitrary amount assignedCould have a stated valueStated value treated as par
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Accounting for the Issuance of Stock
Sell directly to stockholdersUse an underwriter/brokerage firm
Buys unsold stock
Issue price–price received for issuing stockUsually exceeds par value
Stock exchange– here public company stock is traded
NYSE–New York Stock ExchangeNASDQ
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Accounting for the Issuance of StockIssuing 1,000,000 common stock ($1 par) at par
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ASSETS Liabilities Stockholders Equity
Cash Common Stock1,000,000 1,000,000
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Accounting for the Issuance of StockIssuing common stock($1 par) above par
Amount received above par is called a premiumNot a gain; called additional paid-in capitalAnother account is created for the premium amount
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ASSETS Liabilities Stockholders Equity
Cash Common Stock20,000,000 1,000,000
Paid In capital In excess Par - Common
19,000,000
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Stockholders’ Equity Presentation
The balance of the Common stock account is calculated
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Total Paid-in capital is the sum of Common stock plus Paid-in capital in excess of par
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Accounting for Stock IssuancesNo-par stock
No Paid-in capital in excess of par account neededFull amount received is credited to Common stock
Balance sheet shows only the Common stock account
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ASSETS Liabilities Stockholders Equity
Cash Common Stock1,000,000 1,000,000
20,000,000 20,000,000
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Accounting for Stock IssuancesStated value stock
Similar to accounting for par value stockAmount above stated value is credited to Paid-in capital in excess of stated value
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Stated value
Stated value
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Accounting for Stock Issuances
Issuing stock for assets other than cashAsset is debited for its fair value
Building is debited instead of cash
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Accounting for Stock IssuancesIssuing preferred stock
Similar to issuing common stock, except Preferred stock is credited at par value
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ASSETS Liabilities Stockholders Equity
Cash Preferred Stock50,000 50,000
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Accounting for Stock IssuancesPreferred stock usually is not issued above par
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ASSETS Liabilities Stockholders Equity
Cash Preferred Stock55,000 50,000
Paid In capital In excess Par - Preferred
5,000
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Stockholders’ Equity on the Balance Sheet
Equity accounts are listed in the following order on the balance sheet: Preferred stock , Common stock, Retained earnings
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S12-5: ISSUING STOCK AND INTERPRETING STOCKHOLDERS’ EQUITY
Scifilink.com issued stock beginning in 2012 and reported the following on its balance sheet at December 31, 2012:
Common stock, $ 2.00 par valueAuthorized: 6,000 shares
Issued: 4,000 shares $ 8,000Paid-in capital in excess of par 4,000Retained earnings 26,500
Requirement: Journalize the company’s issuance of the stock for cash.
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S12-5: ISSUING STOCK AND INTERPRETING STOCKHOLDERS’ EQUITY
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Journal Entry
DATE ACCOUNTS DEBIT CREDIT
Dec 31 Cash 12,000
Common stock 8,000
Paid in capital in excess of par 4,000
Common stock, $ 2.00 par valueAuthorized: 6,000 sharesIssued: 4,000 shares $ 8,000 Paid-in capital in excess of par 4,000Retained earnings 26,500
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E12-15: ISSUING STOCK
Susie Systems completed the following stock issuance transactions:May 19 Issued 2,000 shares of $1 par common stock for cash of
$9.50 per share.June 3 Sold 300 shares of $3, no-par preferred stock for $15,000
cash.June 11 Received equipment with market value of $78,000. Issued
3,000 shares of the $1 par common stock in exchange.
Requirements:
1. Journalize the transactions. Explanations are not required.
2. How much paid-in capital did these transactions generate for Susie Systems?
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E12-15: ISSUING STOCK
Susie Systems completed the following stock issuance transactions:
May 19 Issued 2,000 shares of $1 par common stock for cash of $9.50 per share.
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Journal Entry
DATE ACCOUNTS DEBIT CREDIT
May 19 Cash 19,000
Common stock 2,000
Paid in capital in excess of par 17,000
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E12-15: ISSUING STOCK
Susie Systems completed the following stock issuance transactions:
June 3 Sold 300 shares of $3, no-par preferred stock for $15,000 cash.
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Journal Entry
DATE ACCOUNTS DEBIT CREDIT
Jun 3 Cash 15,000
Preferred stock 15,000
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E12-15 : ISSUING STOCK
Susie Systems completed the following stock issuance transactions:
June 11 Received equipment with market value of $78,000. Issued 3,000 shares of the $1 par common stock in exchange.
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Journal Entry
DATE ACCOUNTS DEBIT CREDIT
Jun 11 Equipment 78,000
Common stock 3,000
Paid in capital in excess of par 75,000
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E12-15: ISSUING STOCK
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2. How much paid-in capital did these transactions generate for Susie Systems?
$112,000
• 19,000 issue of CS for Cash +• 15,000 issue of PS for Cash +• 78,000 stock issued for equipment
with market value of 78,000
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Retained Earnings Closing entries
Step 1 – Close RevenuesStep 2 – Close Expenses
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Retained EarningsClosing entries
Step 3 – Close Income summary
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Deficit BalanceA loss causes Retained earnings to decrease
A debit balance in Retained earnings is a deficit
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Deficit Balance on Balance Sheet
A deficit is reported as a negative amount
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Accounting for Cash DividendsSometimes a state prohibits using Paid-in capital for dividendsLegal capital is the portion of equity unavailable for dividendsDividends are declared before payingThree dates:
Declaration date–Board declares a dividend and creates a liabilityDate of record–determines which stockholders receives dividendsPayment date–pay dividends and remove liability
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Declaring and Paying DividendsPreferred dividends expressed as either:
A percent of par value
Or a flat dollar amount per share
Common dividends are expressed as a dollar amount per share
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2,000 shares of $100 par 8% preferred = $16,000 dividend
2,000 shares of no-par $3 preferred = $6,000 dividend
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Declaration date
Date of Record (no entry)Payment date
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Declaring and Paying Dividends
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Dividing Dividends Between Preferred and Common
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Note: Preferred dividend per share ($50 x 6%) = $3Annual preferred dividend is (2,000 shares x $3) = $6,000
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Dividing Dividends Between Preferred and Common
Preferred stockholders receive dividends before commonCommon stockholders receive dividends if total declared is large enough to cover preferred
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Cumulative and Noncumulative Preferred Stock
Cumulative preferred stock Accumulates dividends each year until the dividends are paidDividends in arrears—dividends passed or not paid
Noncumulative preferred stock Dividends not paid do not accumulated from one year to the next
Dividend in arrears are paid first, then current dividends paid
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Cumulative PreferredA company declares $50,000 for dividends
In arrears, 1 year at $6,000
Preferred gets $6,000 in arrears + $6,000 currentCommon receives the remainder
Distribution if Preferred is NoncumulativePreferred $6,000Common $44,000
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Cumulative and Noncumulative Preferred Stock
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Different Values of Stock
Market value
• Price at which a person can buy or sell a share• Most important to shareholders
Liquidation value
• Amount guaranteed to preferred if company liquidates
Book value
• Amount of equity per share of stock• If preferred stock exists, subtract preferred equity from total equity to compute book value of common shares
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Book Value of Preferred Stock
Book value attributed to preferred stock + any preferred dividends that are in arrears
Book value attributed to preferred stock is eitherthe number of outstanding preferred shares times liquidation value per share, ORthe book value of preferred equity (the Preferred stock account balance)
Plus any dividends that are in arrears, if the preferred stock is cumulative.
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Book Value per ShareBook value of preferred stock:
Liquidation price or Preferred stock account A
Dividends in arrears on any outstanding preferred shares B
Total book value attributed to preferred stock A+B
Number of outstanding preferred shares C
Book value per share of preferred stock (A+B)/C
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Book value of common stock:
Total stockholders’ equity D
Less: book value attributed to preferred A+B
Total book value attributed to common stock D-(A+B)
Number of outstanding common shares E
Book value per share of common stock D-(A+B)/E
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S12-10 : BOOK VALUE PER SHARE OF COMMON STOCK
Bronze Tint Trust has the following stockholders’ equity:
Bronze Tint has not declared preferred dividends for five years (including the current year).
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Paid-in capital:
Preferred stock, 5%, $10 par, 6,000 shares authorized, 4,500 shares issued
$ 45,000
Common stock, $0.20 par, 1,200,000 shares authorized and issued
240,000
Paid-in capital in excess of par—common 400,000
Total paid-in capital $685,000
Retained earnings 255,000
Total stockholders’ equity $ 940,000
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S12-10: BOOK VALUE PER SHARE OF COMMON STOCK
Compute the book value per share of Bronze Tint’s preferred and common stock.
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Preferred stock
Par value of Preferred stock $45,000
Cumulative dividends 11,250
Total book value attributed to preferred stock 56,250
Number of outstanding preferred shares 4,500
Book value per share of preferred stock $12.50
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S12-10: BOOK VALUE PER SHARE OF COMMON STOCK
Compute the book value per share of Bronze Tint’s preferred and common stock.
(*$ 0.73645833 rounded)
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Common stock
Total stockholders’ Equity $940,000
Less: Preferred equity (56,250)
Common equity $883,750
Number of outstanding Common shares 1,200,000
Book value per share of common stock * $0.74
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Rate of Return on Total AssetsMeasures a company’s success in using assets
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Net income + Interest expense
Average total assets
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Rate of Return on Common Stockholders’ Equity
Relationship between net income available and their average common equity invested
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Net income – Preferred dividends
Average common stockholders’ equity
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S12-11: COMPUTING RETURN ON ASSETS AND RETURN ON EQUITY
Godhi’s 2012 financial statements reported the following items—with 2011 figures given for comparison:
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S12-11: COMPUTING RETURN ON ASSETS AND RETURNON EQUITY
Compute Godhi’s rate of return on total assets and rate of return on common stockholders’ equity for 2012. Do these rates of return look high or low?
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Rate of returnon total assets
=Net income + Interest expense
Average total assets
Rate of return on commonstockholders’ equity
=Net income – Preferred dividends
Average common stockholders’ equity
$3,890 + 210 / $31,550 = 13% (0.12995)
$3,890 - 0 / $15,519 = 25.1% (0.250660)
High
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Income TaxesFederal tax rate of 35% when combined with State taxes can increase total taxes to 40%Corporations measure two income tax amounts
Income tax expense–income statement basedIncome tax payable–IRS taxable income based
Income tax expense Income before tax on the income statement x Income tax rate
Income tax payable Taxable income from the IRS filed tax return x Income tax rate
Major difference–depreciation methods differ46
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Differences Between Income Statement and the Tax Return
ExampleIncome before income tax of $33,000,000
$33,000,000 X 40% = $13,200,000 taxes
Taxable income of $20,000,000$20,000,000 X 40% = $8,000,000 IRS taxes
Difference is $5,200,000 $13,200,000 - $8,000,000Deferred until taxable income catches up
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