Corporations: Organization, Capital Stock Transactions, and Dividends

Instructors Lecture

P.H.

Characteristics of a Corporation
a legal entity, separate from its owners

(stockholders) limited liability

a stockholders loss is limited to his/her investment

subject to double taxation the corporation pays taxes on earnings the stockholder pays taxes on dividends received

Organizational Structure of a Corporation

Stockholders

elect
Board of Directors

selects
Officers hire Employees

Owners Equity in a Corporation

is called Stockholders Equity,

Shareholders Equity, Shareholders Investment, or Capital consists of two main sources:

1. paid-in capital (also called contributed capital) 2. retained earnings

Stockholders Equity:
1. Paid-in capital is capital contributed to

the corporation by the stockholders 2. Retained earnings is net income earned by the corporation and retained (kept) in the business (not distributed to the stockholders in the form of dividends)

Stockholders Equity: Paid-in Capital

Paid-in capital is recorded in separate

accounts for each class of stock, for example, common stock and preferred stock If there is only one class of stock, it is called Common Stock, or Capital Stock

Stockholders Equity: Retained Earnings

Net income or net loss is closed to the

Retained Earnings account at the end of the period The Dividends account (similar to the Drawing account) is also closed the Retained Earnings account

Stockholders Equity: Retained Earnings

Retained earnings is accumulated net

income
net income increases retained earnings dividends decrease retained earnings

Stockholders Equity: Retained Earnings

Retained earnings may also be called

earnings retained for use in the business, or earnings reinvested in the business The normal balance of the Retained Earnings account is credit (remember, it is an owners equity account) A debit balance in the Retained Earnings account is called a deficit, and is the result of accumulated net losses

Stockholders Equity: Retained Earnings

A deficit is deducted from paid-in capital

to determine total stockholders equity Just as net income does not represent cash available, retained earnings does not represent surplus cash

Stockholders Equity: Sources of Paid-In Capital

Stock

Donations of real estate or other assets

Stockholders Equity: Sources of Paid-In Capital Stock

Authorized stated in the charter of the corporation Issued shares issued (sold) to the stockholders Outstanding stock remaining in the hands of the stockholders shares that receive dividends

Stockholders Equity: Sources of Paid-In Capital

Classes of Stock
Common Stock
when there is only one class of stock it is common stock

Preferred Stock
nonparticipating vs. participating
most preferred stock is nonparticipating

cumulative vs. non-cumulative

cumulative preferred stock has the right to receive regular dividends that have been passed (are in arrears) before any common stock dividends are paid

Stockholders Equity: Sources of Paid-In Capital

Preferred Stock
Has preference over common stockholders

in receiving dividends Has preference over common stockholders in receiving assets on liquidation

Stockholders Equity: Sources of Paid-In Capital

Rights of Stockholders
1. The right to vote
2. The right to share in distributions of

earnings (dividends) 3. The right to share in assets on liquidation (the winding up of a corporation when it goes out of business)

Stockholders Equity: Sources of Paid-In Capital

Terms
Par Value a monetary amount that may be assigned to a share of stock related to legal capital (a minimum amount of stockholder contribution that a corporation may be required to retain for the protection of its creditors)
Stated Value some states may require a corporation to assign a stated value to no-par stock

Stockholders Equity: Sources of Paid-In Capital

Issuing (Selling) Stock at Par

Cash Preferred Stock Common Stock

1,500,000 500,000 1,000,000

Stockholders Equity: Sources of Paid-In Capital

Issuing (Selling) Stock at a Premium
Cash Preferred Stock Paid-In Capital in Excess of Par-Preferred Stock* 110,000 100,000 10,000

*When stock is issued at a price that is above par, a separate account is credited for the amount above par

Stockholders Equity: Sources of Paid-In Capital

Issuing (Selling) Stock With a Stated Value at a Premium
Cash Common Stock Paid-In Capital in Excess of Stated Value* 400,000 250,000 150,000

*When no-par stock that has been assigned a stated value is issued at a price that is above par, a separate account is credited for the amount above par

Stockholders Equity
Treasury Stock
Treasury stock is shares of its own stock that a

corporation has once issued and then reacquires The number of shares issued and the number of shares outstanding will be different if the corporation holds treasury stock Shares held in the treasury do not receive dividends Treasury stock reduces total stockholders equity

Stockholders Equity
Reasons for Purchasing Treasury Stock
1. For resale to employees 2. To reissue as a bonus to employees 3. To support (boost) the market price of the

stock

Stockholders Equity
Treasury Stock
Follow the transactions and corresponding

journal entries for treasury stock in your text Use T-accounts to post to the Treasury Stock and Paid-In Capital from Sale of Treasury Stock accounts, and keep track of the number of shares of treasury stock as you do your homework

Stock Splits
A reduction in the par or stated value of a

share of common stock, and the issuance of a proportionate number of additional shares Applies to all shares, including unissued, issued, and treasury shares

Stock Splits
A stock split does not change the total

dollar amount of common stock outstanding; only the par value per share and the number of shares is changed A stock split does not require a journal entrythe details are disclosed in the notes to the financial statements A stock split does not change the proportional ownership in the corporation for an individual stockholder

Stock Splits
Illustrated
Assume that a corporation has 10,000 shares of $100 par value common stock outstanding with a market price of $120 per share. The board of directors declares a 4for-1 stock split. What is the new par value per share, the new total number of shares outstanding, and the the total dollar amount of common stock outstanding after the split?

Stock Splits
Illustrated
before the split
par value per share # of shares outstanding total dollar amount of common stock outstanding

after the split $25 ($100/4) 40,000

(10,000 shares x 4)

$100 10,000 $1,000,000

($100/share x 10,000 shares)

$1,000,000
($25/share x 40,000 shares)

Stock Splits
Illustrated
The proportional ownership in the corporation does not change for an individual stockholder. Lets say a stockholder has 100 shares before the split: % ownership before the split:
100 shares/10,000 shares = 10%

% ownership after the split:

400 shares/ 40,000 shares = 10%

Stock Splits
Illustrated

What would you expect the market price per share to change to?

Stock Splits
Illustrated

Did you get $30?*

*$120/4

Accounting for Dividends

Conditions for a Cash Dividend

1. Sufficient retained earnings declaration of a dividend reduces retained earnings 2. Sufficient cash 3. Formal action by the board of directors

Accounting for Dividends

Important Dates
1. Date of declaration 2. Date of record determines who gets the dividend 3. Date of payment
Journal entries are required for the date of declaration and the date of payment

Accounting for Dividends

Cash Dividends
Dec. 1 Cash Dividends Cash Dividends Payable Declared cash dividend 42,500 42,500

Jan. 2

Cash Dividends Payable Cash

42,500 42,500

Paid cash dividend

Accounting for Dividends

Stock Dividends
Assume the following information for a corporation:
Common Stock, $10 par (200,000 shares issued) On Dec. 15, the board of directors declares a stock dividend of 2% (4,000 shares) to be issued on Jan. 10 to stockholders of record on Dec. 31. The market price of the stock on Dec. 15 is $15 a share.

Accounting for Dividends

Stock Dividends
Dec. 15 Stock Dividends* 60,000

Stock Dividends Distributable** Paid-in Cap. in Excess of Par Declared stock dividend
Jan. 10 Stock Dividends Distributable Common Stock 40,000

40,000 20,000

40,000

Issued stock
*4,000 shares x $15/share (market price per share on Dec. 15) **4,000 shares x 10 share (par value)

Accounting for Dividends

Stock Dividends
A stock dividend does not change the

assets, liabilities, or total stockholders equity of the corporation. It also does not change the proportional ownership in the corporation for an individual stockholder.

Financial Analysis and Interpretation

Dividend Yield Indicates the rate of return to stockholders in terms of cash dividend distributions:
Dividends per share of Common Stock Market Price per share of Common Stock

Dividend Yield

The dividend yield is of special interest to stockholders whose main objective is to receive a current cash return on their investment

Chapter 12: New Accounts

Account Common Stock Preferred Stock Paid-in Capital in Excess of Par/Stated Value Retained Earnings Donated Capital Treasury Stock Paid-in Capital from Sale of Treasury Stock Cash Dividends (temporary account) Cash Dividends Payable Stock Dividends (temporary account) Category S/E S/E S/E S/E S/E S/E S/E S/E Liability S/E Normal Balance Credit Credit Credit Credit Credit Debit Credit Debit Credit Debit

Stock Dividends Distributable

S/E

Credit