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13 Corporations: Organization and Capital Stock Transactions Learning Objectives 13-1 1 Discuss the major characteristics of a corporation. 2 Explain how to account for the issuance of common and preferred stock. 3 Explain how to account for treasury stock. 4 Prepare a stockholders’ equity section. LEARNING OBJECTIVE 1 Discuss the major characteristics of a corporation. An entity separate and distinct from its owners. Classified by Purpose Classified by Ownership Not-for-Profit Publicly held For Profit Privately held ► Salvation Army ► McDonald’s ► American Cancer Society ► Nike ► PepsiCo ► Google 13-2 ► Cargill Inc. Alternative Terminology Privately held corporations are also referred to as closely held corporations. LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-3 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Advantages Disadvantages LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. Corporation acts Separate Legal Existence under its own name rather than in the Limited Liability of Stockholders name of its Transferable Ownership Rights stockholders. Ability to Acquire Capital 13-4 Continuous Life Corporate Management Government Regulations Additional Taxes LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-5 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Limited to their investment. LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-6 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Shareholders may sell their stock. LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-7 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Corporation can obtain capital through the issuance of stock. LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-8 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a stockholder, employee, or officer. LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-9 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Separation of ownership and management often reduces an owner’s ability to actively manage the company. LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-10 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes LO 1 Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. 13-11 Separate Legal Existence Limited Liability of Stockholders Transferable Ownership Rights Ability to Acquire Capital Continuous Life Corporate Management Government Regulations Additional Taxes Corporations pay income taxes as a separate legal entity and in addition, stockholders pay taxes on cash dividends. LO 1 Characteristics of a Corporation Stockholders Illustration 13-1 Corporation organization chart Chairman and Board of Directors President and Chief Executive Officer General Counsel/ Secretary Vice President Marketing Treasurer 13-12 Vice President Finance/Chief Financial Officer Vice President Operations Vice President Human Resources Controller LO 1 Forming a Corporation Initial Steps: File application with the Secretary of State. State grants charter. Corporation develops by-laws. Alternative Terminology The charter is often referred to as the articles of incorporation. Companies generally incorporate in a state whose laws are favorable to the corporate form of business (Delaware, New Jersey). Corporations engaged in interstate commerce must obtain a license from each state in which they do business. 13-13 LO 1 Accounting Across the Organization A Thousand Millionaires! Traveling to space or embarking on an expedition to excavate lost Mayan ruins are normally the stuff of adventure novels. But for employees of Facebook, these and other lavish dreams moved closer to reality when the world’s No. 1 online social network went public through an initial public offering (IPO) that may have created at least a thousand millionaires. The IPO was the largest in Internet history, valuing Facebook at over $104 billion. With all these riches to be had, why did Mark Zuckerberg, the founder of Facebook, delay taking his company public? Consider that the main motivation for issuing shares to the public is to raise money so you can grow your business. However, unlike a manufacturer or even an online retailer, Facebook doesn’t need major physical resources, it doesn’t have inventory, and it doesn’t really need much money for marketing. So in the past, the company hasn’t had much need for additional cash beyond what it was already generating on its own. Finally, as head of a closely held, nonpublic company, Zuckerberg was subject to far fewer regulations than a public company. Source: “Status Update: I’m Rich! Facebook Flotation to Create 1,000 Millionaires Among Company’s Rank and File,” Daily Mail Reporter (February 1, 2012). LO 1 13-14 Stockholder Rights 1. Vote in election of board of directors and on actions that require stockholder approval. 2. Share the corporate earnings through receipt of dividends. Illustration 13-3 Ownership rights of stockholders 13-15 LO 1 Stockholder Rights 3. Keep the same percentage ownership when new shares of stock are issued (preemptive right). * A number of companies have eliminated the preemptive right. Illustration 13-3 Ownership rights of stockholders 13-16 LO 1 Stockholder Rights 4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. Illustration 13-3 Ownership rights of stockholders 13-17 LO 1 Stock Issue Considerations When a corporation decides to issue stock, it must resolve a number of basic questions: 1. How many shares should it authorize for sale? 2. How should it issue the stock? 3. What value should the corporation assign to the stock? 13-18 LO 1 Stock Issue Considerations AUTHORIZED STOCK Charter indicates the amount of stock that a corporation is authorized to sell. Number of authorized shares is often reported in the stockholders’ equity section. 13-19 No formal accounting entry. LO 1 Stock Issue Considerations Prenumbered Shares Illustration 13-4 A Stock certificate Name of corporation Stockholder’s name Signature of corporate official 13-20 LO 1 Stock Issue Considerations ISSUANCE OF STOCK Companies issue common stock directly to investors or indirectly through an investment banking firm. Factors in setting price for a new issue of stock: 1. Company’s anticipated future earnings. 2. Expected dividend rate per share. 3. Current financial position. 4. Current state of the economy. 5. Current state of the securities market. 13-21 LO 1 Stock Issue Considerations MARKET PRICE OF STOCK Stock of publicly held companies is traded on organized exchanges. Interaction between buyers and sellers determines the prices per share. Prices tend to follow the trend of a company’s earnings and dividends. Factors beyond a company’s control may cause day-today fluctuations in market prices. 13-22 LO 1 Investor Insight 13-23 Nike LO 1 Stock Issue Considerations PAR AND NO-PAR VALUE STOCK Years ago, par value determined the legal capital per share that a company must retain in the business for the protection of corporate creditors. Today many states do not require a par value. No-par value stock is fairly common today. In many states, the board of directors assigns a stated value to no-par shares. 13-24 LO 1 Stock Issue Considerations Question Which of these statements is false? a. Ownership of common stock gives the owner a voting right. b. The stockholders’ equity section begins with paid-in capital. c. The authorization of capital stock does not result in a formal accounting entry. d. Legal capital is intended to protect stockholders. 13-25 LO 1 DO IT! 1a Corporate Organization Indicate whether each of the following statements is true or false. False 1. Similar to partners in a partnership, stockholders of a ______ corporation have unlimited liability. True 2. It is relatively easy for a corporation to obtain capital ______ through the issuance of stock. False 3. The separation of ownership and management is an ______ advantage of the corporate form of business. False 4. The journal entry to record the authorization of capital stock ______ includes a credit to the appropriate capital stock account. False 5. All states require a par value per share for capital stock. ______ 13-26 LO 1 Corporate Capital Common Stock Account Paid-in Capital Preferred Stock Paid-in Capital in Excess of Par Account Account Two Primary Sources of Equity Retained Earnings Account Paid-in capital is the total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock. 13-27 LO 1 Corporate Capital Common Stock Account Paid-in Capital Preferred Stock Paid-in Capital in Excess of Par Account Account Two Primary Sources of Equity Retained Earnings Account Retained earnings is net income that a corporation retains for future use. 13-28 LO 1 Corporate Capital If Delta Robotics has a balance of $800,000 in common stock and $130,000 in retained earnings at the end of its first year, its stockholders’ equity section is as follows. 13-29 Illustration 13-5 Stockholders’ equity section LO 1 Corporate Capital Comparison of the owners’ equity (stockholders’ equity) accounts reported on a balance sheet for a proprietorship, a partnership, and a corporation. Illustration 13-6 Comparison of owners’ equity accounts 13-30 LO 1 DO IT! 1b Corporate Capital At the end of its first year of operation, Doral Corporation has $750,000 of common stock and net income of $122,000. Prepare (a) the closing entry for net income and (b) the stockholders’ equity section at year-end. Solution (a) Income Summary 122,000 Retained Earnings (b) Stockholders’ equity Common Stock Retained earnings Total stockholders’ equity 13-31 122,000 Advance slide in slide show to reveal solution. $750,000 122,000 $872,000 LO 1 LEARNING OBJECTIVE 2 Explain how to account for the issuance of common and preferred stock. Accounting for Common Stock Primary Objectives: 1) Identify the specific sources of paid-in capital. 2) Maintain the distinction between paid-in capital and retained earnings. Other than consideration received, the issuance of common stock affects only paid-in capital accounts. 13-32 LO 2 Issuing Par Value Common Stock for Cash Illustration: Assume that Hydro-Slide, Inc. issues 1,000 shares of $1 par value common stock. Prepare Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per share, and (b) 1,000 shares are issued for $5 per share. a. Cash 1,000 Common Stock (1,000 x $1) b. 13-33 Cash 1,000 5,000 Common Stock (1,000 x $1) 1,000 Paid-in Capital in Excess of Par — Common Stock 4,000 LO 2 Accounting for Common Stock Illustration 13-7 Stockholders’ equity—paid-in capital in excess of par 13-34 Alternative Terminology Paid-in Capital in Excess of Par is also called Premium on Stock. LO 2 Issuing No-par Common Stock For Cash Illustration: Assume that instead of $1 par value stock, HydroSlide, Inc. has $5 stated value no-par stock and the company issues 5,000 shares at $8 per share for cash. Cash 13-35 40,000 Common Stock 25,000 Paid-in Capital in Excess of Stated Value— Common Stock 15,000 LO 2 Issuing No-par Common Stock For Cash Illustration: What happens when no-par stock does not have a stated value? Cash Common Stock 13-36 40,000 40,000 LO 2 Issuing Common Stock for Services or Noncash Assets Corporations also may issue stock for: Services (attorneys or consultants). Noncash assets (land, buildings, and equipment). Cost is either the fair market value of the consideration given up, or the fair market value of the consideration received, whichever is more clearly determinable. 13-37 LO 2 Common Stock for Services Illustration: Attorneys have helped Jordan Company incorporate. They have billed the company $5,000 for their services. They agree to accept 4,000 shares of $1 par value common stock in payment of their bill. At the time of the exchange, there is no established market price for the stock. Prepare the journal entry for this transaction. Organizational Expense 13-38 5,000 Common Stock (4,000 x $1) 4,000 Paid-in Capital in Excess of Par— Common Stock 1,000 LO 2 Common Stock for Noncash Asset Illustration: Athletic Research Inc. is an existing publicly held corporation. Its $5 par value stock is actively traded at $8 per share. The company issues 10,000 shares of stock to acquire land recently advertised for sale at $90,000. Prepare the journal entry for this transaction. Land 13-39 80,000 Common Stock (10,000 x $5) 50,000 Paid-in Capital in Excess of Par— Common Stock 30,000 LO 2 Accounting for Preferred Stock Typically, preferred stockholders have a priority as to: 1. Distributions of earnings (dividends). 2. Assets in event of liquidation. Generally do not have voting rights. Accounting for preferred stock at issuance is similar to that for common stock. 13-40 LO 2 Accounting for Preferred Stock Illustration: Stine Corporation issues 10,000 shares of $10 par value preferred stock for $12 cash per share. The journal entry to record the issuance is: Cash 120,000 Preferred Stock (10,000 x $10) Paid-in Capital in Excess of Par— Preferred Stock 100,000 20,000 Preferred stock may have a par value or no-par value. 13-41 LO 2 DO IT! 2 Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 15, it issues 5,000 shares of common stock to attorneys in settlement of their bill of $50,000 for organization costs. On March 28, Cayman Corporation issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares, assuming the shares are not publicly traded. Mar. 1 Cash Common Stock (100,000 x $1) Paid-in Capital in Excess of Par— Common Stock 13-42 1,200,000 100,000 1,100,000 LO 2 DO IT! 2 Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 15, it issues 5,000 shares of common stock to attorneys in settlement of their bill of $50,000 for organization costs. On March 28, Cayman Corporation issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares, assuming the shares are not publicly traded. Mar. 15 Organization Expense Common Stock (5,000 x $1) Paid-in Capital in Excess of Par— Common Stock 13-43 50,000 5,000 45,000 LO 2 DO IT! 2 Issuance of Stock Cayman Corporation begins operations on March 1 by issuing 100,000 shares of $1 par value common stock for cash at $12 per share. On March 15, it issues 5,000 shares of common stock to attorneys in settlement of their bill of $50,000 for organization costs. On March 28, Cayman Corporation issues 1,500 shares of $10 par value preferred stock for cash at $30 per share. Journalize the issuance of the common and preferred shares, assuming the shares are not publicly traded. Mar. 28 Cash 13-44 45,000 Preferred Stock (1,500 x $10) 15,000 Paid-in Capital in Excess of Par— Preferred Stock 30,000 LO 2 LEARNING OBJECTIVE 3 Explain how to account for treasury stock. Common Stock Account Paid-in Capital Preferred Stock Paid-in Capital in Excess of Par Account Account Two Primary Sources of Equity Retained Earnings Account Less: Treasury Stock Account 13-45 LO 3 Accounting for Treasury Stock Treasury stock is a corporation’s own stock that it has reacquired from shareholders but not retired. Corporations acquire treasury stock for various reasons: 1. To reissue the shares to officers and employees under bonus and stock compensation plans. 2. To enhance the stock’s market value. 3. To have additional shares available for use in the acquisition of other companies. 4. To increase earnings per share. 13-46 LO 3 Purchase of Treasury Stock Companies generally use the cost method. Debit Treasury Stock for the price paid to reacquire the shares. Treasury stock is a contra stockholders’ equity account. Reduces stockholders’ equity. Helpful Hint Treasury shares do not have dividend rights or voting rights. 13-47 LO 3 Purchase of Treasury Stock Illustration 13-8 Stockholders’ equity with no treasury stock Illustration: On February 1, 2017, Mead acquires 4,000 shares of its stock at $8 per share. Treasury Stock (4,000 x $8) Cash 13-48 32,000 32,000 LO 3 Purchase of Treasury Stock Illustration 13-9 Stockholders’ equity with treasury stock Both the number of shares issued (100,000) and the number of shares held as treasury (4,000) are disclosed. 13-49 LO 3 Disposal of Treasury Stock Sale of Treasury Stock Above Cost Below Cost Both increase total assets and stockholders’ equity. Helpful Hint Treasury stock transactions are classified as capital stock transactions. As in the case when stock is issued, the income statement is not involved. 13-50 LO 3 SALE OF TREASURY STOCK “ABOVE” COST Illustration: On July 1, Mead sells for $10 per share 1,000 shares of its treasury stock previously acquired at $8 per share and makes the following entry. Cash 10,000 Treasury Stock 8,000 Paid-in Capital from Treasury Stock 2,000 A corporation does not realize a gain or suffer a loss from stock transactions with its own stockholders. 13-51 LO 3 SALE OF TREASURY STOCK “BELOW” COST Illustration: On Oct. 1, Mead sells an additional 800 shares of treasury stock at $7 per share and makes the following entry. Cash Paid-in Capital from Treasury Stock Treasury Stock Illustration 13-10 Treasury stock accounts 13-52 5,600 800 6,400 LO 3 SALE OF TREASURY STOCK “BELOW” COST Illustration: On Dec. 1, assume that Mead, Inc. sells its remaining 2,200 shares at $7 per share and makes the following entry. Cash Paid-in Capital from Treasury Stock 1,200 Retained Earnings 1,000 Treasury Stock 13-53 15,400 Limited to balance on hand 17,600 LO 3 Accounting Across the Organization Why Did Reebok Buy Its Own Stock? In a bold (and some would say risky) move, Reebok at one time bought back nearly a third of its shares. This repurchase of shares dramatically reduced Reebok’s available cash. In fact, the company borrowed significant funds to accomplish the repurchase. In a press release, management stated that it was repurchasing the shares because it believed its stock was severely underpriced. The repurchase of so many shares was meant to signal management’s belief in good future earnings. Skeptics, however, suggested that Reebok’s management was repurchasing shares to make it less likely that another company would acquire Reebok (in which case Reebok’s top managers would likely lose their jobs). By depleting its cash, Reebok became a less attractive acquisition target. Acquiring companies like to purchase companies with large cash balances so they can pay off debt used in the acquisition. 13-54 LO 3 DO IT! 3 Treasury Stock Santa Anita Inc. purchases 3,000 shares of its $50 par value common stock for $180,000 cash on July 1. It will hold the shares in the treasury until resold. On November 1, the corporation sells 1,000 shares of treasury stock for cash at $70 per share. Journalize the treasury stock transactions. Solution July 1 Treasury Stock 180,000 Cash Nov. 1 Cash 13-55 180,000 70,000 Treasury Stock 60,000 Paid-in Capital from Treasury Stock 10,000 LO 3 LEARNING OBJECTIVE 4 Prepare a stockholder’s equity section Companies report paid-in capital and retained earnings in the stockholders’ equity section of the balance sheet. Paid-in capital includes: 1. Capital stock. Preferred stock appears before common stock because of its preferential rights. Companies report par value, shares authorized, shares issued, and shares outstanding for each class of stock. 2. Additional paid-in capital. Excess amounts paid in over par or stated value and paid-in capital from treasury stock. 13-56 LO 4 13-57 Illustration 13-11 Stockholders’ equity section LO 4 DO IT! 4 Stockholders’ Equity Section Jennifer Corporation has issued 300,000 shares of $3 par value common stock. It authorized 600,000 shares. The paid-in capital in excess of par on the common stock is $380,000. The corporation has reacquired 15,000 shares at a cost of $50,000 and is currently holding those shares. Treasury stock was reissued in prior years for $72,000 more than its cost. The corporation also has 4,000 shares issued and outstanding of 8%, $100 par value preferred stock. It authorized 10,000 shares. The paid-in capital in excess of par on the preferred stock is $25,000. Retained earnings is $610,000. Prepare the stockholders’ equity section of the balance sheet. 13-58 LO 4 13-59 LO 4 A Look at IFRS LEARNING OBJECTIVE 5 Compare the accounting for stockholders’ equity under GAAP and IFRS. Key Points Similarities 13-60 Aside from the terminology used, the accounting transactions for the issuance of shares and the purchase of treasury stock are similar. Like GAAP, IFRS does not allow a company to record gains or losses on purchases of its own shares. LO 5 A Look at IFRS Key Points Differences 13-61 Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences. Many countries have a different mix of investor groups than in the United States. For example, in Germany, financial institutions like banks are not only major creditors of corporations but often are the largest corporate stockholders as well. In the United States, Asia, and the United Kingdom, many companies rely on substantial investment from private investors. LO 5 A Look at IFRS Key Points 13-62 There are often terminology differences for equity accounts. The following summarizes some of the common differences in terminology. LO 5 A Look at IFRS Key Points 13-63 A major difference between IFRS and GAAP relates to the account Revaluation Surplus. Revaluation surplus arises under IFRS because companies are permitted to revalue their property, plant, and equipment to fair value under certain circumstances. This account is part of general reserves under IFRS and is not considered contributed capital. IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used. Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and share holders’ funds. LO 5 A Look at IFRS Looking to the Future The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements. 13-64 LO 5 A Look at IFRS IFRS Self-Test Questions Which of the following is true? a) In the United States, the primary corporate stockholders are financial institutions. b) Share capital means total assets under IFRS. c) The IASB and FASB are presently studying how financial statement information should be presented. d) The amount to treasury stock is very different between U.S. GAAP and IFRS. 13-65 LO 5 A Look at IFRS IFRS Self-Test Questions Under IFRS, the amount of capital received in excess of par value would be credited to: a) Retained Earnings. b) Contributed Capital. c) Share Premium. d) Par value is not used under IFRS. 13-66 LO 5 A Look at IFRS IFRS Self-Test Questions Which of the following does not represent a pair of GAAP/IFRScomparable terms? a) Additional paid-in capital/Share premium. b) Treasury stock/Repurchase reserve. c) Common stock/Share capital. d) Preferred stock/Preference shares. 13-67 LO 5 Copyright “Copyright © 2015 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” 13-68
