Docstoc

Corporations

Document Sample
Corporations Powered By Docstoc
					Corporations

A.   Corporation--a corporation is an artificial entity created by obtaining
     approval under the laws of the state in which it is incorporated

B.   Characteristics of a Corporation
     1. Separate Legal Entity--a corporation engages in business activities
         under its own name instead of the names of the owners
         a. Government Regulation--a corporation is subject to a greater amount
             of regulation from federal and state governments than sole
             proprietorships and partnerships
     2. Unlimited Life--the life of the corporation is not terminated when
         there is a change in ownership of the corporation
         a. Transferability of Ownership--ownership of a corporation is
             exhibited by shares of stock and can be transferred to another
             stockholder entirely at the discretion of the stockholder
         b. Ownership Rights of Stockholders--each share of stock represents a
             proportional ownership right in the corporation
             1) Voting--stockholders have the right to vote in the election of
                 a board of directors and to vote on actions that require
                 stockholder approval
                 a) Preferred Stock--stockholders who own preferred stock,
                     instead of common stock, give up their right to vote in
                     return for preferential treatment in regards to dividends
                     and liquidation
             2) Dividends--stockholders have the right to share in the earnings
                 of the corporation through the receipt of dividends
             3) Preemptive Right--the stock holders have the right to maintain
                 the same percentage ownership when new shares of stock are
                 issued
             4) Liquidation--the stockholders have the right to share in the
                 assets of the corporation upon liquidation
     3. Limited Liability--each stockholders’ liability is usually limited to
         their investment in the corporation
         a. Ability to Raise Capital--because of the limited liability of the
             corporate form of organization and the ease of transferability of
             ownership, the ability of corporations to raise large amounts of
             capital is increased
         b. Owners’ Equity Accounts--separate owners’ accounts are maintained
             to account for the original investment of the owners (which usually
             has to be kept in the corporation) and for the net income of the
             corporation (which can be withdrawn from the corporation through
             the payment of dividends)
             1) Contributed Capital--contributed capital accounts are used to
                 account for the original investment of the owners
             2) Retained Earnings--a retained earnings account is used to
                 account for the net income of the corporation


                                        1
     4.   Taxation--the net income of the corporation is taxed at the corporate
          level when it is earned and again at the stockholder level when it is
          paid as a dividend

C.   Contributed Capital--contributed capital represents the amount provided by
     stockholders to the corporation for use in the corporation
     1. Issuance
         a. Cash Issuance
             1) Par Value Stock--par value stock is capital stock with an
                 arbitrary value assigned to the capital stock that represents
                 the minimum amount at risk from investment in the corporation
                 a) Accounting Treatment
                     I) Capital Stock--the capital stock account is credited
                         for the par value of the capital stock
                    II) Paid-in Capital--the paid-in capital in excess of par
                         account is credited for the difference between the
                         issue price of the capital stock and its par value
                         A) Discount--if capital stock is issued for less than
                              its par value, a discount account is debited for
                              the difference between the issue price of the
                              capital stock and its par value and represents the
                              amount the original purchaser or the current holder
                              of the capital stock may be forced to pay to
                              prevent creditors from sustaining a loss upon the
                              liquidation of the corporation
                 b) Illustration--a corporation issued 10,000 shares of common
                     stock with a par value of $5 for $15 per share
                         Cash                                   150,000
                         (10,000 x 15)
                              Common Stock                                 50,000
                              (10,000 x 5)
                              Paid-in Capital in Excess of
                              Par--Common Stock                          100,000
                              (10,000 x 10)

              2)   No-par Stock--no-par stock is capital stock with no per-share
                   value assigned to the capital stock
                   a) Accounting Treatment--the capital stock account is credited
                       for the issue price of the capital stock
                       I) Stated Value--if no-par stock is either required or
                           allowed to have a stated value, the issuance of the
                           capital stock is recorded in the same way as par value
                           stock
                   b) Illustration--a corporation issued 10,000 shares of no-par
                       common stock for $15 per share




                                          2
                      Cash                                  150,000
                      (10,000 x 15)
                           Common Stock                               150,000

     b.   Noncash Issuance--capital stock is issued for services or property
          other than cash
          1) Accounting Treatment--the issue price of the capital stock is
              equal to either the fair market value of the securities issued
              or the fair market value of the services or property received
              if the fair market value of the securities is not determinable
          2) Illustrations
              a) A corporation issued 10,000 shares of common stock with a
                  par value of $5 and a fair market value of $15 for land
                  with a fair market value of $152,000
                      Land                                  150,000
                           Common Stock                               50,000
                           (10,000 x 5)
                           Paid-in Capital in Excess of
                           Par--Common Stock                         100,000
                           (10,000 x 10)

             b)   A corporation issued 10,000 shares of common stock with a
                  par value of $5 for land with a fair market value of
                  $152,000; the fair market value of the common stock is
                  unknown
                      Land                                  152,000
                           Common Stock                                50,000
                           (10,000 x 5)
                           Paid-in Capital in Excess of
                           Par--Common Stock                         102,000
                           (152,000 – 50,000)

2.   Reacquisition--the reacquisition of capital stock is the repurchase of
     previously issued capital stock from stockholders to provide
     preferential tax distributions to stockholders, to increase earnings
     per share, to provide stock for employee stock compensation plans, to
     provide stock for business acquisitions, to prevent takeover attempts,
     etc.
     a. Treasury Stock--treasury stock is capital stock that is repurchased
         and held in the treasury for reissue
         1) Accounting Treatment--the repurchase and the subsequent reissue
             of the capital stock are treated as one transaction for
             gain/loss purposes
             a) Date of Repurchase--no gain or loss on the treasury stock
                 is recognized at the date of repurchase
                 I) Treasury Stock--the treasury stock account is debited
                     for the repurchase price of the capital stock


                                      3
                  A)   Presentation--the treasury stock account is
                       reported as a deduction from the total paid-in
                       capital and retained earnings
          b) Date of Reissue--gain or loss on the treasury stock is
              recognized at the date of reissue
              I) Treasury Stock--the treasury stock account is credited
                  for the repurchase price of the capital stock
             II) Gain/Loss--the difference between the repurchase price
                  of the capital stock and its reissue price is credited
                  to the paid-in capital from treasury stock account if
                  the repurchase price is less than the reissue price or
                  debited first to the paid-in capital from treasury
                  stock account to the extent of any credit balance in
                  the paid-in capital from treasury stock account and
                  then to the retained earnings account if the repurchase
                  price is greater than the reissue price
     2)   Illustration--a corporation purchased 1,000 shares of common
          stock at $14 per share; the common stock has a par value of $5
          and was originally issued at $15 per share; the corporation
          reissued 100 shares of common stock at $16 per share and 300
          shares of common stock at $13 per share
              Treasury Stock                              14,000
              (1,000 x 14)
                  Cash                                             14,000

              Cash                                        1,600
              (100 x 16)
                   Treasury Stock                                  1,400
                   (100 x 14)
                   Paid-in Capital from Treasury Stock               200
                   (1,600 – 1,400)

              Cash                                        3,900
              (300 x 13)
              Paid-in Capital from Treasury Stock           200
              ((3,900 – 4,200) or 200)
              Retained Earnings                             100
              (300 – 200)
                   Treasury Stock                                  4,200
                   (300 x 14)

b.   Retirement--the retirement of capital stock is the repurchase and
     cancellation of previously issued capital stock
     1) Accounting Treatment
         a) Capital Stock--the capital stock is debited for the par
             value of the capital stock
         b) Paid-in Capital--the paid-in capital in excess of par


                                  4
                 account is debited for the difference between the original
                 issue price of the capital stock and its par value
             c) Gain/Loss--the difference between the repurchase price of
                 the capital stock and its original issue price is credited
                 to the paid-in capital from retirement account if the
                 repurchase price is less than the original issue price or
                 debited to the retained earnings account if the repurchase
                 price is greater than the original issue price
        2)   Illustrations
             a) A corporation repurchased 1,000 shares of preferred stock
                 at $105 per share; the preferred stock had a par value of
                 $100 and was originally issued at $106 per share
                     Preferred Stock                       100,000
                     (1,000 x 100)
                     Paid-in Capital in Excess of
                     Par--Preferred Stock                    6,000
                     (1,000 x 6)
                         Cash                                       105,000
                         (1,000 x 105)
                         Paid-in Capital from Retirement of
                         Preferred Stock                              1,000
                         (1,000 x 106 – 105,000)

             b)   A corporation repurchased 1,000 shares of preferred stock
                  at $105 per share; the preferred stock had a par value of
                  $100 and was originally issued at $103 per share
                      Preferred Stock                       100,000
                      (1,000 x 100)
                      Paid-in Capital in Excess of
                      Par--Preferred Stock                    3,000
                      (1,000 x 3)
                      Retained Earnings                       2,000
                      (1,000 x 103 – 105,000)
                          Cash                                       105,000
                          (1,000 x 105)

3.   Dilutive Securities--dilutive securities are equity securities that
     enable the stockholder to acquire shares of common stock in the future
     a. Convertible Preferred Stock--convertible preferred stock is
         preferred stock that may be converted into common stock
         1) Accounting--the original issue price of the preferred stock is
             treated as the issue price of the common stock
             a) Preferred Stock--the preferred stock account is debited for
                 the par value of the preferred stock converted
             b) Paid-in Capital--the paid-in capital in excess of par--
                 preferred stock account is debited for the original issue
                 price of the preferred stock and its par value


                                     5
                   c)  Common Stock--the common stock account is credited for the
                       par value of the common stock issued from the conversion
                   d) Paid-in Capital--the paid-in capital in excess of par--
                       common stock account is credited for the difference between
                       the original issue price of the preferred stock and the par
                       value of the common stock issued from the conversion
              2)   Illustration--a corporation issued 10,000 shares of convertible
                   preferred stock with a par value of $100 for $103 per share;
                   each share of preferred stock is convertible into 2 shares of
                   common stock with a par value of $40; stockholders exercised
                   the conversion feature on 1,000 shares of preferred stock
                       Preferred Stock                            100,000
                       (1,000 x 100)
                       Paid-in Capital in Excess of Par--Preferred
                       Stock                                        3,000
                       (1,000 x 3)
                           Common Stock                                     80,000
                           (2 x 1,000 x 40)
                           Paid-in Capital in Excess of Par--Common
                           Stock                                            23,000

         b.   Preferred Stock With Detachable Stock Warrants--detachable stock
              warrants are certificates, which are issued along with preferred
              stock, enabling the stockholder to acquire shares of common stock
              at a certain price within a stated period of time
              1) Accounting--the accounting for preferred stock with detachable
                  stock warrants is beyond the scope of this course
         c.   Stock Options--a stock option is an option to purchase common stock
              at a given price over an extended period of time given to selected
              employees to motivate their performance
              1) Accounting--the accounting for stock options is beyond the
                  scope of this course

D.   Retained Earnings--retained earnings represents the net income of the
     corporation that has not been paid to the stockholders in the form of a
     dividend
     1. Distributions
         a. Cash Dividends--cash dividends are the proportionate distribution
             of cash to the stockholders
             1) Dividend Dates
                 a) Accounting Treatment
                     I) Date of Declaration--the date of declaration is the
                         date on which the board of directors formally declares
                         the dividend and requires the recording of the decrease
                         in retained earnings and the recognition of the
                         liability to pay the dividend
                    II) Date of Record--the date of record is date on which


                                          6
             ownership of the stock is determined and requires no
             entry
       III) Date of Payment--the date of payment is the date on
             which the dividend is paid and requires the elimination
             of the liability to pay the dividend
     b) Illustration--on September 1 a corporation declared a cash
         dividend of $10,000 payable on September 15 to stockholders
         who own the stock on September 10
             September 1:
                 Retained Earnings                  10,000
                     Dividends Payable                       10,000

             September 10:
                 No Entry

             September 15:
                 Dividends Payable                  10,000
                     Cash                                    10,000

2)   Dividend Preferences--preferred stockholders have the right to
     share in the net income of the corporation before common
     stockholders
     a) Accounting Treatment
         I) Cumulative Preferred Stock--any preferred stock
             dividends that were not paid in prior years must be
             paid before the current year dividends are paid
             A) Dividends in Arrears--dividends in arrears are the
                  preferred stock dividends that were not paid in
                  prior years and are not considered a liability
        II) Noncumulative Preferred Stock--any preferred stock
             dividends that were not paid in prior years do not
             carryover to the current year
     b) Illustrations
         I) A corporation had 1,000 shares of 6% noncumulative
             preferred stock with a par value of $100 and 8,000
             shares of common stock with a $50 par outstanding; the
             corporation declared a cash dividend of $50,000; no
             dividends were paid last year
                            _ Preferred Stock_    _ Common Stock _
             Prior Year              ---
             Current Year           6,000               44,000
                            (6% x 100 x 1,000)     (50,000 – 6,000)
                                    6,000               44,000

       II)   A corporation had 1,000 shares of 6% cumulative
             preferred stock with a par value of $100 and 8,000
             shares of common stock with a $50 par outstanding; the


                             7
                 corporation declared a cash dividend of $50,000; no
                 dividends were paid last year
                               _ Preferred Stock_    _ Common Stock _
                 Prior Year            6,000
                               (6% x 100 x 1,000)
                 Current Year          6,000               38,000
                                      _    _          (50,000 – 12,000)
                                      12,000               38,000

b.   Stock Dividends--stock dividends are the proportionate distribution
     of additional shares of stock in the corporation to the
     stockholders
     1) Accounting Treatment--retained earning is decreased and
         contributed capital is increased by the market value of the
         stock distributed as a stock dividend
     2) Illustration--a corporation declared a 5% stock dividend when
         the corporation had 10,000 shares of common stock with a $15
         par outstanding; the market value of the common stock was $42
         per share
             Retained Earnings                           21,000
             (5% x 10,000 x 42)
                  Common Stock                                     7,500
                  (500 x 15)
                  Paid-in Capital in Excess of Par--Common Stock 13,500
                  (500 x 27)
                      The market value of the stock should drop to $40
                      per share (10,000 x 42 / (10,000 + 500)). If you
                      owned 200 shares of stock before the stock dividend
                      and 210 shares (200 + 5% x 200) of stock after the
                      stock dividend, your wealth has remained unchanged
                      (200 x 42 = 210 x 40).

c.   Stock Splits--stock splits are the proportionate distribution of
     shares of stock in the corporation to the stockholders together
     with a proportionate decrease in the par value of the stock
     1) Accounting Treatment--no entry is necessary to record a stock
         split since the total par value of stock has remained unchanged
     2) Illustration--a corporation issued a 2-for-1 stock split when
         the corporation had 10,000 shares of common stock with a $15
         par outstanding; the market value of the common stock was $42
         per share
             No Entry
                 The market value of the stock should drop to $21 per
                 share (10,000 x 42 / 2 x 10,000). If you owned 200
                 shares of stock before the stock dividend and 400
                 shares (2 x 200) of stock after the stock dividend,
                 your wealth has remained unchanged (200 x 42 = 400 x


                                8
                    21).

2.   Retained Earnings Restrictions--the amount of retained earnings that
     are available for dividend may be restricted by legal restrictions (the
     cost of the treasury stock is a restriction on retained earnings
     available for dividend payments in most states), contractual
     restrictions (debt agreements may restrict the amount of dividends that
     can be paid), and voluntary restrictions (the board of directors may
     voluntarily restrict the amount of dividends that can be paid in order
     to earmark the resources for such company needs as expansion)
     a. Accounting Treatment--restrictions on retained earnings are
         generally disclosed in the notes to the financial statements
     b. Illustration--the owners’ equity of a corporation consisted of
         common stock of $100,000, retained earnings of $50,000, and
         treasury stock of ($20,000)
             Notes:
                 The corporation had unrestricted retained earnings of
                 $30,000 (50,000 – 20,000).
                     If the corporation were allowed to pay out the entire
                     $50,000 of retained earnings as a dividend, the capital
                     invested by the stockholders would be reduced to
                     $80,000 (100,000- 20,000).




                                    9