Chapter 11 Notes
ACC 100
04/14/25
11.1 Corporate Form of Organization
Corporation– an entity separate and distinct from its owners
* Created by law, and its continued existence depends upon the statutes of the state in which it is incorporated
* As a legal entity, a corporation has most of the rights and privileges of a person
* The major exceptions relate to privileges that only a living person can exercise (such as the right to vote, etc.)
* A corporation is subject to the same duties and responsibilities as a person
* Must abide by laws and pay taxes
* Two common ways to classify corporations are by purpose and by ownership
* Profit or not-for-profit
* A publicly held corporation may have thousands of stockholders
* A privately held corporation usually only has a few stockholders and does not offer its stock for sale to the general public
Characteristics of a Corporation
* Separate Legal Existence
* As an entity separate and distinct from its owners, the corporation acts under its own name rather than in the name of its stockholders
* Buy, own, and sell property
* Borrow money
* Enter into legally binding contracts in its own name (as well as sue and be sued)
* Limited Liability of Stockholders
* Limited to their investment in the corporation
* Creditors have no legal claim in the personal assets of the stockholders unless fraud has occurred
* Even in the event of bankruptcy, stockholders’ losses are generally limited to their capital investment in the corporation
* Transferable Ownership Rights
* Shares of capital stock represent ownership in a corporation
* Transferable units
* Stockholders may dispose of part or all of their interest in a corporation simply by selling their stock
* The transfer of an ownership interest in a partnership requires the consent of each owner
* In contrast, the transfer of stock is entirely at the discretion of the stockholder
* Doesn’t require the approval of either the corporation or other stockholders
* The transfer of ownership rights between stockholders normally has no effect on the daily operating activities of the corporation
* Nor does it affect the corporation’s assets, liabilities, and total ownership equity
* The transfer of these ownership rights is a transaction between individual owners
* Ability to Acquire Capital
* Bing stock in a corporation is often attractive to an investor because a stockholder has limited liability and shares of stock are readily transferable
* Numerous individuals can become stockholders by investing relatively small amounts of money
* Continuous Life
* The life may be perpetual, or it may be limited to a specific number of years
* If it’s limited, the company can extend the life through renewal of the charter
* It’s continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer
* Corporation management
* Stockholders elect a board of directors
* The board formulates the operating policies for the company
* CEO has overall responsibility for managing the business
* Delegates responsibility to other officers
* The chief accounting officer is the controller
* The controller’s responsibilities include:
* Maintaining the accounting records
* Ensuring an adequate system of internal control
* Preparing financial statements, tax returns, and internal reports
Treasurer– has custody of the corporation’s funds and is responsible for maintaining the company’s cash position
* Government Regulations
* State laws usually prescribe the requirements for issuing stock, the distributions of earnings permitted to stockholders, and the acceptable methods for buying back and retiring stock
* Federal securities laws govern the sale of capital stock to the general public
* Most publicly held corporations are required to make extensive disclosure of their financial affairs to the Securities and Exchange Commission (SEC) through quarterly and annual reports
* Additional Taxes
* Ownership of proprietorships and partnerships report their shares to the company’s earnings on their personal income tax returns
* Corporations must pay federal and state income taxes as a separate legal entity
* Stockholders must pay taxes on cash dividends (pro rata distributions of net income)
* Many argue that the government taxes corporate income twice (double taxation)--once at the corporate level and again at the individual level
Forming a Corporation
→ a corporation is formed by grant of state charter
* Regardless of the number of states in which a corporation has operating divisions, it is incorporated in only one state
* Corporation establishes by-laws
* By-laws establish internal rules and procedures for conducting affairs of the corporation
Organization costs– costs incurred in the formation of a corporation
* Include legal and state fees, and promotional expenditures involved in the organization of the business
* Corporations expense organization costs as incurred
* Determining the amount and timing of future benefits is so difficult that it’s standard procedure to take a conservative approach of expensing these costs immediately
Stockholder Rights
* When a corporation has only one class of stock, it’s common stock
Stock certificate– proof of stock ownership
Authorized Stock
* The charter indicates the maximum number of shares that a corporation is authorized to sell
* The total amount of authorized stock at the time of incorporation normally anticipates both initial and subsequent capital needs
* The number of shares authorized generally exceeds the number initially sold
* The authorization of capital stock does ot result in a formal accounting entry
* The event has no immediate effect on either corporate assets or stockholders’ equity
* The number of authorized shares is often reported in the stockholders’ equity section of the balance sheet
Issuance of Stock
* A corporation can issue common stock directly or indirectly
* Directly to investors
* Indirectly through an investment banking firm that specializes in brining securities to the attention of prospective investors
* Indirect Issuance
* The investment firm may agree to underwrite the entire stock issue
* The investment banker buys the stock from the corporation at a stipulated price and resells the shares to investors
* Corporation avoids any risk of being unable to sell the shares
* Obtains immediate use of the cash received from the underwriter
* Corporations set the price for a new issue of stock by considering:
* The company’s anticipated future earnings
* Its expected dividend rate per share
* Its current financial position
* The current state of the economy
* The current state of the securities market
Par and No-Par Value Stocks
Par value stock– capital stock to which the charter has assigned a value per share
No-par value stock– capital stock to which the charter has not assigned a value
* Fairly common today
* In many states, the board of directors assigns a stated value to no-par shares
Stated value– the amount per share assigned by the board of directors to no-par stock
Corporate Capital
* Owners’ equity for a corporation is identified by various names: stockholders’ equity, shareholders’ equity, or corporate capital
* Stockholders’ equity section of a corporation’s balance sheet consists of:
* Paid-in (contributed) capital
* retained earnings (earned capital)
* Can make distributions of earnings (declare dividends) out of retained earnings in all states
Paid-In Capital
→ the total amount of cash and other assets paid into the corporation by stockholders in exchange for capital stock
Retained earnings
→ net income that a corporation retains for future use
JE to close income summary and transfer net income to retained earnings:
DR. Income Summary 130,000
CR. Retained earnings 130,000
11.2 Accounting for Common, Preferred, and Treasury Stock
Accounting for Common Stock
* Identify the specific sources of paid-in capital
* Maintain the distinction between paid-in capital and retained earnings
* Issuance of common stock affects only paid-in capital accounts
Issuing Par Value Common Stock for Cash
JE to record issuance of 1,000 shares of $1 common stock at par:
DR. Cash 1,000
CR. Common Stock 1,000
JE to record issuance of 1,000 shares of common stock in excess of par:
DR. Cash 5,000
CR. Common Stock 1,000
CR. Paid-in Capital in Excess of Par 4,000
Accounting for Preferred Stock
→ an additional class of stock issued by a corporation to appeal to a larger segment of potential investors
* Has contractual provisions that give it preference of priority over common stock in certain areas
JE to record issuance of 10,000 shares of $10 par value preferred stock:
DR. Cash 120,000
CR. Preferred Stock 100,000
CR. Paid-in Capital in Excess of Par—Preferred Stock 20,000
Accounting for Treasury Stock
→ a corporation’s own stock that has been reacquired by the corporation and is being held for future use
* May acquire treasury stock:
* To reissue the shares to officers and employees under bonus and stock compensation plans
* To increase trading of the company’s stock in the securities market. Companies expect that buying their own stock will signal that management believes the stock is underpriced, which they hope will enhance its market price
* To have additional shares available for use in acquiring other companies
* To reduce the number of shares outstanding and thereby increase earnings per share
Purchase of Treasury Stock
* Generally accounted for by the cost method
JE to record purchase of 4,000 shares of treasury stock at $8 per share:
DR. Treasury Stock 32,000
CR. Cash 32,000
* The original paid-in capital account, Common Stock, would not be affected because the number of issued shares does not change
* Once a share has been issued, a subsequent repurchase of that share as treasury stock does not affect its status as “issued”
Outstanding stock– means the number of shares of issued stock that are currently being held by stockholders
11.3 Accounting for Dividends and Stock Splits
Dividend– a corporation’s distribution of cash or stock to its stockholders on a pro rata (proportional to ownership) basis
* Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend
* Dividends can take four forms: cash, property, scrip (a promissory note to pay cash), or stock
* Cash dividends predominate in practice although companies also declare stock dividends with some frequency
Cash Dividends
→ a pro rata distribution of cash to stockholders
* Cash dividends are not paid on treasury shares
* For a corporation to pay a cash dividend, it must have:
* Retained earnings
* Adequate cash
* Declared dividends
Entries for Cash Dividends
* Important dates
* The declaration date
* The record date
* The payment date
* Companies make accounting entries on the declaration date and the payment date and NOT on the record date
* Declaration date
* The board of directors formally declares (authorizes) the cash dividend and announces it to stockholders
* Commits the corporation to a legal obligation
* JE to record declaration of cash dividend:
DR. Cash Dividends 50,000
CR. Dividends Payable 50,000
* Record date
* The company determines ownership of the outstanding shares for dividend purposes
* NO ENTRY
* Payment date
* The company makes cash dividend payments to the stockholders of record and records the payment of the dividend
* JE to record payment of cash dividend:
DR. Dividends Payable 50,000
CR. Cash 50,000
* The cumulative effect of the declaration and payment of a cash dividend is to decrease both stockholders’ equity and total assets
* JE to close cash dividends to retained earnings:
DR. Retained earnings 50,000
CR. Cash Dividends 50,000
Dividend Preferences
* Preferred stockholders have the right to receive dividends before common stockholders
* If the dividend rate on preferred stock is $5 per share, common stockholders cannot receive any dividends in the current year until preferred stockholders have received $5 per share
Cumulative Dividend
* Stipulates that preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders are paid any dividends
Dividends in arrears– when preferred stock is cumulative, preferred dividends not declared in a given period
* The company cannot pay dividends to common stockholders until it pays the entire preferred dividend
* Companies cannot pay dividends to common stockholders while any preferred dividends are in arrears
* Dividends in arrears are not considered a liability
* No payment obligation exists until the board of directors formally declares that the corporation will pay a dividend
Stock Dividends
→ a pro rata distribution of the corporation’s own stock to stockholders
* A stock dividend transfers an amount from retained earnings to paid-in capital, thus decreasing retained earnings and increasing paid-in capital
* Unlike a cash dividend, a stock does not decrease total stockholders’ equity or total assets
Stock Splits
→ involves issuance of additional shares to stockholders according to their percentage ownership
* Results in a reduction in the par or stated value per share
* The purpose of a stock split is to increase the marketability of the stock by lowering its market price per share
* A stock split does not have any effect on total paid-in capital, retained earnings, or total stockholders’ equity
* A company does not need to journalize a stock split
11.4 Presentation and Analysis