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					                                                    CAPITAL

Accounting Theory
A corporation is an entity separate from the owners. This follows the separate-entity assumption which is the
company is considered as an accounting unit separate and apart from the owner or owners. The entity theory is
more closely related to widely held corporations. The entity theory is income centered (income statement);
accounting is focused on the entity and states that the liabilities and capital are the sources of the assets. The
accounting equation is Assets = Liabilities + Capital.

In contrast the proprietary theory is asset centered (balance sheet), accounting is focused on the proper
determination of owners’ equity and states that attention to determining the asset values and liability amounts
result in the proper determination of owners' equity. The accounting equation is Assets - Liabilities = Owners
Equity. The proprietary theory is more closely related to closely held corporation, limited liability companies,
partnerships and sole proprietorships.

Corporate Capital
Total equity                             Both creditor equity and owners' equity.
Owners' equity / Proprietary equity      Contributions by the owners and retained earnings and treasury stock.
Contributed capital                      Contributions by the owners including paid-in capital.
Legal or stated capital                  Contributions by the owners that is required by statute to remain in the
                                           business for the protection of creditors.


Legal or Stated Capital
Legal capital cannot be returned to the owners through dividends or by purchase of shares held by them (treasury
stock) unless creditor claims are first satisfied. Par-value of all outstanding shares is legal capital. For no-par-
value stock with a stated-value the stated-value of all outstanding shares is legal capital. For no-par-value the full
proceeds from the sale of no-par stock must be treated as legal capital.

If legal capital is impaired through dividend payments or purchase of the corporation's own shares (treasury
stock) creditors may obtain payment from the shareholders to the extent of such impairment. Full disclosure
requires that the amount of legal capital be reported and the excess of legal capital also be reported.


Basic Rights of Shareholders
Ownership in a corporation is represented by shares of capital stock. When there is only one class of stock all
owners have the same rights. When there is more than one class of stock the holders of one class of stock may
have rights that are not associated with the other classes of stock. The basic rights of a shareholder are:

Participate in management by voting in the stockholder meetings.
Participate in profits by dividends.
Distribution of assets upon corporate dissolution through liquidation dividends.
Distribution of assets upon corporate payment of dividends when paid-in capital accounts are charged through
 liquidating dividends (capital dividends).
Distribution of assets upon corporate payment of dividends when paid-in capital accounts are charged through
 capital dividends.
Purchase additional shares to protect proportional interest.
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Contributed Capital
Contribution from the owners (contributed capital) is classified based on the following terms:

Authorized capital stock          The number of shares of stock that can be issued legally.
Issued capital stock              The number of shares of stock that have been issued.
Unissued capital stock            The number of shares of stock that have never been issued.
Outstanding capital stock         The number of shares of stock that have been issued and are held by
                                    stockholders.
Treasury stock                     The number of shares of stock that have been issued and later
                                     reacquired by the corporation. Difference between the issued shares
                                      and outstanding shares.
Subscribed stock                   The number of unissued shares of stock that have been set aside to meet
                                      subscription contracts. Subscribed stock is issued upon full payment
                                      of the subscription price.


Owners' equity / Proprietary Equity
Contributed capital (paid in capital) is the amount of no-par-value, no-par-value with a stated-value and par-
value of the issued and subscribed shares of each class of capital stock including preferred stock and common
stock.

   No-par-value stock does not carry a designated dollar value per share and may be either common stock
    or preferred stock.

   No-par-value with a stated-value per share is established by the corporate directors or the bylaws of the
   corporation and may be either common stock or preferred stock. The use of stated-value stock serves
   to place the no-par stock on the same basis as par-value stock for accounting purposes. The stated-value
   provides a measure of protection for the creditors.

   Par-value stock has a designated dollar value per share as provided for in the articles of incorporation and may
   either common stock or preferred stock. The par-value provides a measure of protection for the creditors.

Other contributed capital is the premium on stock - amounts paid by the owners in excess of par-value or stated-
value.
Other contributed capital can come from non owners by the donation of assets.

Retained earnings that are appropriated (not available for dividends) including a reserve for bond sinking fund or
a contingent liability. Retained earnings that are not appropriated (available for dividends).

Unrealized increment from write up of fixed assets based on new information regarding the value of the fixed
asset.


Common Stock
Common stock is the basic issue of shares and carries the rights of shareholders mentioned above. When there is
only one class of stock it is common stock.

Preferred Stock
Preferred shareholders have the same basic rights as common shareholders.

Preferred stock is usually par-value stock. The dividend preference is expressed as a percentage of the par-value
of each share. When preferred stock is no-par-value the dividend preference is expressed as a specific dollar
amount per share.
                                                   CAPITAL



Preferred stock entitles the owners to a preference over the common stock. The preferences relate to:
Dividends cumulative or noncumulative
 Cumulative dividends provide that if a dividend is not declared for any year or series of years they accumulate
 and must be paid to the preferred shareholders when dividends are declared before the common shareholders
 receive a dividend. These dividends are referred to as dividends in arrears.

  Noncumulative dividends provide that if a dividend is not declared for any year they are lost permanently.

Dividends fully participating, partially participating or nonparticipating with common stock stockholders.
 Fully participating is when the preferred shareholders are entitled to extra dividends on a pro rata basis based
 on par-value or stated-value with the holders of common stock. Common shareholders match the preferred
 shareholders dividend percentage and any dividend remaining is allocated with the holders of common stock on
 a pro rata basis.

 Partially participating is when the preferred shareholders participate above the preferential rate with the holders
 of common stock but only up to an additional rate which is specified in the charter and on the stock certificate.
 Common shareholders match the preferred shareholders dividend percentage and any dividend remaining is
 allocated to the preferred shareholders at the additional rate (preferential rate minus the dividend rate) with
 the balance to the common shareholders. Should there be no dividend balance remaining the allocation is on a
 pro rata basis based on par-value or stated-value with the holders of common stock.

 Nonparticipating is when the dividends on the preferred stock for any one year are limited in the charter, stock
 contract and on the stock certificate to a specified preferential rate. Common shareholders match the preferred
 shareholders dividend percentage and any dividend remaining is allocated to the common shareholders.


  Examples: Preferred Stock dividend is 5%...Cumulative...Dividends in arrears 3 years...Par-Value $100
             Shares issued and outstanding 5,000. Total $500,000.

              Common Stock Par-Value $100... shares issued and outstanding 10,000. Total 1,000,000.

              Total Dividends Declared $168,000.


FullyParticipating:                                                     Preferred       Common
Dividend $168,000
Preferred Shareholders
Dividends in arrears                 $75,000                             $75,000
Current year dividend                 25,000                              25,000
Balance ratably with par                              $6,000               6,000

Common Shareholders
Current year dividend 5%              50,000                                            $50,000
Balance ratably with par                                12,000                           12,000

Total                                 $150,000        $18,000             $106,000       $62,000
                                                CAPITAL




Partially Participating Up To 7%:                            Preferred    Common
Dividend $168,000
Preferred Shareholders
Dividends in arrears                $75,000                  $75,000
Current year dividend                25,000                   25,000
Partial participation 2%                           $10,000    10,000

Common Shareholders
Current year dividend 5%             50,000                               $50,000
Balance                                             8,000                   8,000

Total                                $150,000      $18,000    $110,000    $58,000




Partially Participating Up To 7%:
Dividend $156,000                                             Preferred    Common
Preferred Shareholders
Dividends in arrears                $75,000                  $75,000
Current year dividend                25,000                   25,000
Partial participation 2%                          $2,000       2,000

Common Shareholders
Current year dividend 5%             50,000                               $50,000
Balance                                            4,000                    4,000

Total                                $150,000     $6,000      $102,000    $54,000




Nonparticipating:                                             Preferred    Common
Dividend $168,000
Preferred Shareholders
Dividends in arrears                $75,000                  $75,000
Current year dividend                25,000                    25,000

Common Shareholders
Current year dividend 5%             50,000                               $50,000
Balance                                          $18,000                   18,000

Total                               $150,000     $18,000     $100,000     $68,000
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Asset distributions upon liquidation.
Preferred stock that is preferred as to assets upon corporate dissolution provides the preferred shareholders a
priority up to the par-value or stated-value per share over common shareholders. When the priority has been
satisfied for the preferred shareholders the remainder of the assets are available for distribution to the common
shareholders.

Redemption.
Preferred stock having redemption privileges (redeemable stock) allow the preferred shareholder under specified
conditions stated on the stock certificate or in the preferred stock contract to sell the shares back to the
corporation at a specified price per share.

Convertibility to common stock.
Preferred stock having a convertibility privilege (convertible stock) allow the preferred shareholder to convert the
preferred stock for other securities including common stock.

Preferred stock may be callable which allows the corporation to purchase the preferred stock under specified
conditions of time and price and to cancel the shares. The liquidation preference of the preferred stock should be
disclosed in the equity section of the balance sheet in the full amount in accordance with the full disclosure
principle.



Stock Premium
A premium paid on the purchase of capital stock is recorded as contributed capital. Paid-in capital should remain
in the accounts until the stock is retired. If the stock is retired the related premium should be removed from the
accounts. When dividends are allowed by state law and the charge is to paid-in capital the shareholders receiving
these dividends should be informed that the dividends are a return of the original investment. They are a
liquidating dividend not a distribution of retained earnings.

Stock Rights
This is a very interesting topic. A stock right is an opportunity for a stockholder to purchase additional shares of
stock at a specific price and by a specific date in the future. The rights can be granted subsequent to the purchase
date of the stock when the market price of the stock has appreciated. The number of shares owned is the number
of stock rights even though the number of shares that can be subscribed for is not the same as the shares owned.
The value of the stock rights is the opportunity to purchase additional shares at a lower price than the current fair
market value of the stock. As the market value of the stock changes so does the market value of the stock rights.

Stock rights can be sold, exercised or allowed to expire. If the stock rights are sold a gain or loss must be
determined so an allocation of the cost of the stock purchase is made between the stock and the stock rights. The
allocation of cost is calculated by the relative sales value method.
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Stock Rights - Issue Provides Subscribed Shares Same as Shares Owned -
Market Price of Stock Rights Determinable
For example 1,000 shares of common stock cost $100,000 which is $100 per share. The fair market value of the
stock at the time of the issuance of the stock rights is $147 per share (ex rights) and the fair market value of the
stock rights at the time of issuance is $28 per share for a total value of $175 per share (rights on) for both. The
cost of $100,000 is allocated as follows:

Existing common stock $147 (ex rights) divided by $175 (rights on) times $100,000 = Apportioned cost $84,000
  Cost per share is $84.00

New stock rights $28 divided by $175 (rights on) times $100,000 = Apportioned cost $16,000
 Cost per right is $16.00

Assume further that the issue of stock rights provides a subscription for one share of stock at a price of $119 for
each one share owned. The new stock rights value can be determined as follows:

Existing common stock $175 (fair market value) minus $119 (conversion price) =$56 divided by sum of one
  plus one (2) = $28 value per right

Ex rights price is $175 (fair market value) minus $28 (value of rights) = $147

 Value of stock rights is $147 (ex rights price) minus $119 (conversion price) = $28 divided by 1 = $28 value of
stock rights.


If the rights are exercised the cost of the acquired stock includes the cost of the rights and the conversion price of
the stock acquired. Per the above example there are 1,000 stock rights providing for a subscription of 1,000
shares of stock. If all 1,000 stock rights are exercised the purchase cost is as follows:

Cost of stock 1,000 shares at $119 per share = $119,000
Cost of stock rights 1,000 rights              $ 16,000

Total                                               $135,000


If one right is exercised the purchase cost is as follows:

Cost of stock 1 shares at $119 per share =      $    119.00
Cost of stock rights 1 right                    $     16.00

Total                                            $ 135.00
                                                     CAPITAL


Stock Rights - Issue Provides Subscribed Shares Less Than Owned Shares -
Market Price of Stock Rights not Determinable
When the market price of a stock right cannot be determined in the market the parity value of the right can be
used. The parity value is the sales value of the right calculated based on the fair market value of the stock and the
lower price that the holder of the right can purchase the additional shares. The parity value is determined by
calculating the difference between the fair market value of the purchased stock prior to issuance of the stock rights
(rights on) and the lower price that the holder of the right can purchase the additional shares and dividing that by
the number of rights required to purchase one new share plus one. For example the fair market value of the
purchased stock is $175 per share (rights on) and the issue of stock rights provides a subscription for one share of
stock at a price of $125 for each four shares owned.

Existing common stock $175 (fair market value) minus $125 (conversion price) =$50 divided by sum of four plus
  one (5) = $10 parity value per right.

Ex rights price is $175 (fair market value) minus $10 (parity value) = $165

Parity values is $165 (ex rights price) minus $125 (conversion price) = $40 divided by 4 = $10 parity value per
right.

Existing common stock $165 (ex rights) divided by $175 (rights on) times $100,000 = Apportioned cost is
  $94,286 Cost per share is $94.286.

New stock rights $10 divided by $175 (rights on) times $100,000 = Apportioned cost $5,714
 Cost per right is $5.714.


If the rights are exercised the cost of the acquired stock includes the cost of the rights and the conversion price of
the stock acquired. Per the above example there are 1,000 stock rights providing for a subscription of 250 shares
of stock. If all 1,000 stock rights are exercised the purchase cost is as follows:

Cost of stock 250 shares at $125 per share = $31,250
Cost of stock rights 1,000 rights            $ 5,714

Total                                            $36,964


If four rights are exercised the purchase cost is as follows:

Cost of stock 1 shares at $125 per share =      $ 125.00
Cost of stock rights 4 rights                   $ 22.86

Total                                           $ 147.86


If stock rights are not sold or exercised they will expire and a loss is recognized equal to the cost allocated to the
stock rights.
                                                      CAPITAL


Stock Warrants Issued With Debt
A company may sell bond obligations with warrants to purchase stock because of a lower interest cost. The
exercise of the warrants is dependent upon the market price of the stock. When bonds are sold with stock
warrants a portion of the price must be assigned to the bonds with the balance to the stock warrants.

For example $200,000 of bonds are issued and each $1,000 bond carries four stock warrants for a total of 800
warrants. Each warrant provides the option to purchase one share of common stock at $150 a share. Current
market value of the stock is $130 per share and par-value is $100 per share. The warrants market value is $20 per
share. Total value of the warrants is $16,000 (800 * $20). The bond sold at a discount of $10,000. All warrants
are exercised when the stock market value of the stock is $160 a share.

Market value of stock on date stock rights issued     $170 (ex rights)
Market value of stock rights on date issued             20
Market value of stock and rights before issued         $190 (rights on)

Calculation of value of stock rights:
Ex rights    $170 - $150 = $20 / 1 = $20

Rights on    $190 - $150 = $40 / 2 = $20

The entry to record the sale of the bonds and warrants is:      Debit             Credit

Cash                                                           $206.000
Bonds Discount                                                   10,000
     Bonds Payable                                                              $200,000
     Stock Warrants Payable                                                       16,000


The entry to record the exercise of the warrants to              Debit            Credit
purchase 800 shares of capital stock:

Cash                                                            $120,000
Stock Warrants Payable                                            16,000
     Capital Stock                                                               $80,000
     Paid-in Capital                                                              56,000

Paid-in capital is the premium paid on the purchase of capital stock. The exercise price is $150 per share and the
par-value is $100 per share for a premium of $50 per share times the 800 shares issued (800 warrants exercised)
amounting to $40,000 plus the amount of the stock warrants of $16,000 for a total of $56,000.
                                                  CAPITAL


If 600 shares were issued (600 warrants exercised) the premium would have been $42,000. (600 shares *$50 =
$30,000) plus (600 warrants * $20 = $12,000). The 200 unexercised warrants are reclassified to paid in capital
in the amount of $4,000. That brings paid on capital to a balance of $46,000. The remaining $10,000 is the
premium on the 200 warrants not exercised (200 warrants * $50).

The total amount paid for the 800 shares is $136,000 or $170 per share. The market value of the 800
shares when the warrants were exercised is $128,000 or $160 per share. There appears to be an $8,000 loss.
When considering the bond discount of $10,000 there appears to be a profit of $2,000. The bond
discount amounts to $12.50 per share for a total value when the warrants were issued of $138,000 or $172.50 per
share ($160 + $12.50) or ($170 + $2.50). The $2,000 is $2.50 per share ($2,000 / 800).

After the warrants are exercised the value or the stock is $128,000 and the value of the bond is $200,000 for a
total of $328,000. The cost is $326,000. Profit of $2,000.

                                    Bond             Stock             Total

Amount paid                      $190,000           $16,000           $206,000
Exercise stock rights                               120,000            120.000
Bond discount                       10,000           -10,000                 0

Total                            $200,000           $126,000            $326,000

Number of shares                                        800

Cost per share                                       $157.50
FMV per share                                        $160.00


Where the sales price of the bonds cannot be allocated between the debt and the warrants there is no allocation to
paid-in capital. Regarding this example there would be no allocation to the warrants and the bonds would have
been sold for a premium of $6,000.



Stock Sold For Consideration Other Than Cash
When stock is sold for consideration other than cash the assets received should be valued based on which value is
more definitely determinable in the following order:
Current market value of the assets received.
Current market value of the stock issued.
Appraised value of the assets received.
Valuation of the assets by the board of directors.
Par-value or stated-value of the stock issued.

Assets that are not correctly valued create an overstatement (watered stock) or understatement (secret reserves) of
contributed capital.

When stock is sold for performance of services the services should be valued based on which value is more
definitely determinable in the following order:
Fair value of the services performed.
Current market value of the stock issued.
Book value of the stock.
Par-value or stated-value of the stock issued.
                                                    CAPITAL


Stock acquired for consideration other than cash is recorded at the fair market value of the consideration given
up if determinable or the fair market value of the stock acquired if that is more definitely determinable. When
stock is acquired by exchanging existing stock the acquired stock is recorded at its fair market value or the fair
market value of the stock given up whichever is more determinable. An example would be acquiring common
stock by exchanging preferred stock. The cost of the acquired common stock is its fair market value if more
determinable than the fair market value of the preferred stock. An investment in a closely held company or an
unlisted stock for consideration other than cash will require appraisals and estimates to determine cost. When
more than one class of stock is purchased for a single sum the cost is allocated among the classes according to the
relative sales value of the classes.


Incorporation of Existing Sole Proprietorship or Partnership
When the same ownership and management of the business continues the book value of the accounts can be
carried forward. The accounting can also be recorded by adjusting the accounts to the fair market value of
the assets. If the fair market value of the assets cannot be determined then the fair market value of the stock can
be used.

If the original books are retained entries are done to adjust the accounts to fair market value and to close the
owner equity accounts. Corporate capital accounts (contributed capital) are then recorded.

If new books are opened the entries on the old books are to adjust the accounts to fair market value and to close all
accounts. The entries on the new books are to record the receipt of the new assets and to record the issuance of
stock. The old company records the receipt of the stock in exchange for the owner’s equity and the distribution to
the owners.

Any write up of the assets is credited to owners’ equity in accordance with the owner’s allocation share of profit
and loss. Goodwill, the excess of the purchase price over the fair market value of the assets, is credited to owner’s
equity in accordance with the owner’s allocation of profit and loss. Any distribution of assets to the owners is
allocated as determined by the owners. It can be on the basis of the capital balances or profit and loss allocation.
Finally the stock is issued on the basis of the owners adjusted capital balances.


For example if the value the new company including goodwill is $20.50 per share and 10,000 shares were issued
the total value is $205,000. The par-value of the stock is $20. Paid-in capital is $5,000. The partner’s capital
balances after adjustments for asset write up, goodwill and distributions is $205,000. Partner A capital balance is
$153,750 and Partner B is $51,250. Partner A would receive 7,500 shares ($153,750 / $20.50) and Partner B
would receive 2,500 shares ($51,250 - $20.50). Par-value for Partner A is $150,000 (7,500 * $20) with paid-in
capital of $3,750 (7,500 * $.50). Par-value for Partner B is $50,000 (2,500 * $20) with paid-in capital of $1,250
(2,500 * $.50).

Tax Purposes
For income tax purposes the book value of the assets transferred is the cost basis in the new corporate entity
provided control is continued by the original owners. Control is 80% of the issued voting stock.




Retained Earnings
Retained earnings comprise in addition to contributed capital what is referred to as Owners' Equity / Proprietary
Equity. Retained earnings are the accumulated net income and losses and dividends distributions. Retained
earnings are reduced by stock dividends which are transfers to permanent capital accounts (contributed capital).
Retained earnings can be either unappropriated or appropriated. Appropriated retained earnings are recorded by
a credit to appropriated retained and a debit to unappropriated retained earnings.

The sources of proprietary equity are the main concern of accounting theory regarding corporate capital.
                                                   CAPITAL


Other source of contributed capital (paid-in capital) include:
Premium on capital stock.
Excess of no-par-value stock with a stated-value over the stated-value.
Conversion by the corporation of its own stock.
  A corporation cannot realize income on capital transactions between itself and the shareholders.
  Convertible preferred stock into other classes of capital stock. Conversion recorded at par-value of the
  respective classes of stock. Paid-in capital from conversion credited when par-value of the preferred
  shares is more than the par-value of the common shares received from the conversion.
Gain or loss on treasury stock transactions.
  Cost Method
  Resale of treasury stock at a price above the purchase cost.
  Resale of treasury stock at a price below the purchase cost.
  Retire treasury stock when the purchase cost is above par-value.
  Retire treasury stock when the purchase cost is below par-value.
  Par-Value Method
  Purchase of treasury stock - Original Issue paid-in capital.
  Purchase of treasury stock - Cost below original issue par-value.
  Resale of treasury stock at a price above the purchase cost.
Loss on treasury stock transactions.
  Resale of treasury stock at a price below the purchase cost except as noted below (source of retained
   earnings).
Reduction in par or stated value of the corporations own stock.
  Shares are changed from par-value to true no-par stock.
  Shares are changed from par-value to no-par-value stock with a stated-value different than par-value.
  Original shares issued were true no-par and are changed to shares having a par-value.
Assessment on shareholders only if the original stock was issued at a discount.
Donations of assets to the corporation.
Amount received by the corporation on certain forfeitures of stock subscriptions.
Certain quasi-reorganization adjustments.
  Paid-in capital adjusted to zero.


Other sources of contributed capital are available for dividends depending on state statutes.
                                                   CAPITAL


Source of Retained Earnings include:
Net income and loss.
Extraordinary items.
Prior period adjustments.
Gains or losses from discontinued operations.
Cash and property dividends
Stock dividends (treasury stock or unissued stock).
Treasury stock requirements.
 State law may have a legal requirement to appropriate retained earnings to the cost of treasury stock in order
  that the amount is not available for dividends. This protects the working capital position and provides
  protection to creditors.
Loss on treasury stock resale transactions.
  Cost Method
  When there is a lack of appropriate contributed capital accounts to absorb the charge.
  Par-Value Method
  When the resale amount per share is below the par-value.
Purchase of treasury stock.
  Par-Value Method
  When the purchase cost is above the par-value and paid-in capital of the original stock issued.
Retire treasury stock.
  Cost Method
  When the purchase cost is above the par-value and paid-in capital of the original stock issued.
Conversion by the corporation of its own stock.
  A corporation cannot realize income on capital transactions between itself and the shareholders.
  Convertible preferred stock into other classes of capital stock. Conversion recorded at par-value of the
   respective classes of stock. Retained earnings from conversion debited when the par-value of the preferred
   shares is less than the par-value of the common shares received from the conversion.
Recapitalizations including quasi-reorganizations.

Dividends
A distribution to the shareholders is a dividend. If the dividend is in a form other than cash it should be recorded
according to the form of disbursement in accordance with the full disclosure principle.

A distribution of corporate assets and a decrease in proprietary equity occurs with the following dividends:
Cash dividend.
Property dividend.
Liquidating dividend (a return of capital):
 Distribution of assets upon corporate dissolution through liquidation dividends.
 Distribution of assets upon corporate payment of dividends when paid-in capital accounts are charged through
   liquidating dividends (capital dividends).
 Distribution of assets upon corporate payment of dividends when paid-in capital accounts are charged through
   capital dividends.

The creation of a liability and a decrease in proprietary equity occurs with the following dividends:
Cash dividend declared but not paid.
Liability / Script dividend:
 A liability dividend occurs when the board of directors declares a dividend and issues promissory notes, bonds
 or script (a promise to pay) to the shareholders. This type of dividend occurs when the corporation has
 retained earnings but does not have the cash. Promissory notes and bonds bear interest and have a due date.
 Script may or may not bear interest and usually has a due date. At times there may not be a due date that being
 left to the board of directors.
                                                    CAPITAL


Neither a distribution of corporate assets or the creation of a liability or a decrease in proprietary equity with the
following dividend:
Stock dividend. Retained earnings are reduced by stock dividends which are transfers to permanent capital
accounts (contributed capital).

Liquidating dividends may be either intentional or unintentional.

An intentional dividend occurs when the board of directors knowingly declares dividends that are a return of
investment to the shareholders such as when a corporation is discontinuing operations or when there is
capitalization in excess of what is required. Paid-in capital is charged rather than retained earnings for a
liquidating dividend because the shareholders investment is being returned. Liquidating dividends are not taxable
to the shareholder but they reduce the cost basis of the stock.

Unintentional liquidating dividends may occur when net income is overstated through error or omission. Sales
and gains could be overstated and expenses could be understated. In this situation retained earnings would also
be overstated. After correction for the error or omission retained earnings may be a deficit. If a deficit exists the
dividends to the extent of the deficit is a liquidating dividend. The deficit causing part of the dividend should be
reclassified to paid-in capital thus recording that part of the dividend as a liquidating dividend.

A stock dividend is a distribution of additional shares of common stock or preferred stock to the shareholders. It
can be in the form of treasury stock or unissued stock. An ordinary stock dividend is of the same class held by the
shareholder. A special stock dividend is of a different class of stock than that held by the shareholder. A stock
dividend raises legal capital since it is a permanent transfer of capital. Ordinary stock dividends are not subject to
income taxes unless the shareholder had the option to be paid in cash but they reduce the cost basis of the stock.

Ordinary Stock Dividend - Same Class of Stock Held by Shareholder
Small Stock Dividend - When the additional shares are small compared to the total shares outstanding the fair
market value of the additional shares should be the amount of retained earnings transferred to contributed
capital. A small stock dividend does not affect the market value of the shares. Many factors have to be considered
regarding market value per share but the issuance of additional shares up to 25 % of the total outstanding shares
should be accounted for as a small stock dividend.

Large Stock Dividend - When the additional shares are large compared to the total shares outstanding the par-
value or stated-value of no-par-value stock with a stated-value of the additional shares should be the amount of
retained earnings transferred to contributed capital. Retained earnings should only be capitalized if the large
stock dividend does not materially affect the market value of the shares. Par-value or stated-value of no-par-value
stock with a stated-value does not change with a large stock dividend even though the market value may be
reduced.

When a large stock dividend has the effect of materially reducing the market value of the shares retained earnings
should not be capitalized. This would be a stock split in the form of a stock dividend.

Special Stock Dividend - Different Class of Stock Than Held by Shareholder
For both small stock dividend and large stock dividend the fair market value of the additional shares should be
the amount of retained earnings transferred to contributed capital.
                                                   CAPITAL


Dividend Reporting on the Balance Sheet
The liability for a cash dividend, property dividend or liability dividend is recorded on the date of declaration by
the board of directors. A stock dividend does not require the use of assets for payment so no liability is recorded
on the date of declaration. The date of payment is also determined by the board of directors. The date of payment
is when the liability recorded at the date of declaration is debited. It is also the date when the stock dividend is
recorded. The shareholders at the date of record also determined by the board directors receive the dividend.


If a stock dividend payable is recorded at the date of declaration and the date of payment is after the balance sheet
date the stock dividend payable should be reported in the proprietary equity section of the balance sheet. Stock
dividends payable are reported as contributed capital while cash and property dividends payable are reported as
liabilities.

If a stock dividend is paid by treasury stock the amount capitalized to retained earnings by a small stock dividend
is fair market value. The amount capitalized to retained earnings by a large stock dividend is the minimum of
par-value or stated-value of no-par-value stock with a stated-value. For a large stock dividend the cost of the
treasury stock may exceed the par-value. In that case retained earnings is capitalized by the cost of the treasury
stock. The excess of the amount capitalized to retained earnings and the cost of the treasury stock is recorded as
paid-in capital from Treasury Stock Dividend. This provides full disclosure of source.

Dividends in arrears on cumulative preferred stock are not a liability until the dividend shave been declared by
the board of directors. Dividends in arrears should be disclosed in the balance sheet and may be reported as a part
of the unappropriated retained earnings.



Stock Split
A stock split increases the number of shares and involves a pro rata reduction in the par-value per share. The total
par-value of the issued and outstanding shares remains the same after a stock split. The old shares are replaced by
a greater number of new shares with a smaller par-value per share. A stock split does not cause a transfer of
retained earnings to permanent capital accounts (contributed capital).



Appropriation of Retained Earnings
Appropriation of retained earnings is a restriction on a portion of the total retained earnings for a specific
purpose. When the need for the appropriation no longer applies the appropriation account is debited and the
unappropriated retained earnings account is credited. An appropriation account is never debited for a loss or any
other purpose, any resultant loss must be reported on the income statement.

Appropriation of retained earnings may be for the following purposes:
Legal requirement such as the cost of treasury stock.
  State law may have a legal requirement to appropriate retained earnings to the cost of treasury stock in order
  that the amount is not available for dividends. This protects the working capital position and provides
  protection to creditors.
Contractual agreement.
  Bond issue where the bond indenture requires a sinking fund and carries a requirement providing for a
  restriction on retained earnings.
Actions by the Board of Directors
  To restrict retained earnings for future financial planning such as new property, plant and equipment,
   business acquisitions, investments in research and development and working capital.

  The board of directors may once the appropriation as described above is returned to unappropriated retained
  earnings declare a stock dividend for the same amount thus permanently capitalizing the earnings. They may
  also increase the par-value or stated-value of no-par-value stock with a stated-value thus permanently
  capitalizing the earnings.
                                                   CAPITAL


  To restrict retained earnings for possible known future losses such as contingencies, purchase commitment
  losses for future inventory cost decline, lawsuits where an unfavorable outcome is known to be probable and
  losses from self-insurance.


Appropriation of Retained Earnings for Self-Insurance
The aggregate amount of the expected loss can be appropriated or the appropriation from period to period be
recorded in the amount of the cost of the insurance premium. Actual loss is recorded on the income statement.
The appropriation method can be used when the losses cannot be estimated as to timing and amount. If the
losses can be estimated as to timing and amount the accrual method should be used.

Accrual Method for Self-Insurance
Insurance expense is debited and an accrued liability is credited for the approximate amount of the loss in the
current period. Actual losses are recorded to the accrued liability account. The amount of the loss must be based
on information that the expected future loss will materialize. The accrual method should only be used when there
is a sound objective basis for accrual accounting with respect to such losses. Accrual accounting is acceptable for
losses from self-insurance only when the loss can be estimated with reasonable accuracy. Accrual accounting for
self-insurance losses should not be used in an arbitrary manner to equalize earnings from period to period.


Prior Period Adjustments
Adjustments related to prior periods and thus excluded in the determination of net income for the current period
are limited to those material adjustments which can be :

Specifically identified with and directly related to the business activities of particular prior periods.
Are not attributable to economic events occurring subsequent to the date of the financial statements for the prior
period.
Depend primarily on determinations by persons other than management.
Were not susceptible of reasonable estimation prior to such determination.
Are not a change in accounting principle, estimate or method.


Extraordinary Items
Events and transactions of a character significantly different from the typical business activities of the entity.
They will be events and transactions of material effect which would not be expected to recur frequently and which
would not be considered as recurring factors in any evaluation of the ordinary process of the business. Examples
of extraordinary items include:

Material gains and losses from the sale or abandonment of a plant or a significant segment of the business.
The sale of an investment not acquired for resale.
The write-off of goodwill due to unusual events or developments within the period.
The condemnation of properties.
Major devaluation of a foreign currency.


Neither Prior Period Adjustments nor Extraordinary Items
Certain gains of losses regardless of size do not constitute prior period adjustments or extraordinary items
because they are of a character typical of the customary business activities of the entity. Examples include:

Write-down of receivables, inventories and research and development costs.
Adjustments of accrued contract prices.
                                                  CAPITAL


Statement of Retained Earnings
The following items should be reported on the Statement of Retained Earnings:

Adjustments for prior periods including the income tax applicable to the prior period adjustments.
Net income and loss for the current period.
Dividends
Appropriations
Adjustments made pursuant to a quasi-reorganization.
   Retained earnings after the quasi-reorganization must be zero.
Adjustments, charges, or credits, resulting from transactions in the company's own stock. (treasury stock and
   stock conversions).
Treasury stock requirements.
 State law may have a legal requirement to appropriate retained earnings to the cost of treasury stock in order
  that the amount is not available for dividends. This protects the working capital position and provides
  protection to creditors.
Loss on treasury stock resale transactions.
  Cost Method
  When there is a lack of appropriate contributed capital accounts to absorb the charge.
  Par-Value Method
  When the resale amount per share is below the par-value.
Purchase of treasury stock.
  Par-Value Method
  When the purchase cost is above the par-value and paid-in capital of the original stock issued.
Retire treasury stock.
  Cost Method
  When the purchase cost is above the par-value and paid-in capital of the original stock issued.
Conversion by the corporation of its own stock.
  A corporation cannot realize income on capital transactions between itself and the shareholders.
  Convertible preferred stock into other classes of capital stock. Conversion recorded at par-value of the
   respective classes of stock. Retained earnings from conversion debited when the par-value of the preferred
   shares is less than the par-value of the common shares received from the conversion.


The statement of retained earnings should be in two sections...Unappropriated Retained Earnings and
Appropriated Retained Earnings.




Small Business is the Engine that Drives our Economy. The Men and Women who Work to make our Country Great
           Should be Recognized for their Achievement and Courage in Very Difficult Economic Times.

				
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