Financial Accounting, 5e
Weygandt, Kieso, & Kimmel
Prepared by
Kurt M. Hull, MBA CPA
California State University, Los Angeles
John Wiley & Sons, Inc.
CHAPTER 12
CORPORATIONS
STUDY OBJECTIVES
After studying this chapter, you should understand:
Corporate
characteristics
Entries for cash dividends
and stock dividends
How to record the
issuance of common stock
Accounting for
treasury stock
Difference between
common & preferred stock
Content of retained
earnings statement
Presentation & analysis
STUDY OBJECTIVE 1
CORPORATE CHARACTERISTICS
Separate legal existence
Limited liability
Transferable ownership
Advantages
Ability to acquire capital
Continuous life
Management vs. ownership
Disadvantages
Government regulation
Double taxation
Corporations may be publicly or privately owned
FORMING A CORPORATION
Steps to form a corporation
A. Application
B. Charter
C. By-laws
Organizational costs are expensed as incurred.
OWNERSHIP RIGHTS OF STOCKHOLDERS
STOCK ISSUE CONSIDERATIONS
Authorized Shares indicated by charter.
Issued
Shares sold to investors directly or indirectly.
Market
Set by interaction between buyers and sellers.
Par
Assigned value/stated value/legal capital
No par
No assigned value
STUDY OBJECTIVE 2
ISSUING COMMON STOCK
Primary objectives in issuing common stock.
Identify specific sources of paid-in capital
Maintain the distinction between
paid-in capital and retained earnings.
ISSUING PAR VALUE
COMMON STOCK FOR CASH
If the issue price = par value,
proceeds are credited to common stock.
Assume Hyrdo-Slide Inc., issues 1,000 shares
of $1 par value common stock at par:
Date
Account
1/1/xx Cash
Common Stock
(record issuance at par)
Debit
Credit
1,000
1,000
ISSUING PAR VALUE
COMMON STOCK FOR CASH
If the issue price < > par value, proceeds
are split between common stock and
paid-in capital in excess of par value
Assume Hyrdo-Slide Inc., issues 1,000 shares
of $1 par value common stock at $5 per share:
Date
1/1/xx
Account
Cash
Debit
Credit
5,000
Common Stock
1,000
Paid-in capital in excess of par value
4,000
(record issuance in excess of par)
REVIEW QUESTION
On July 1, ABC Corporation issues 1,000 shares
of $10 par value common stock at $12 per share.
What is the entry to record this transaction?
Date
July 1
Account
Cash
Common Stock
Paid-in capital in excess of par value
(record issuance in excess of par)
Debit
Credit
12,000
10,000
2,000
STOCKHOLDERS’ EQUITY SECTION
The total paid-in-capital from these transactions is $6,000, and the
legal capital is $2,000. If Hydro-Slide, Inc. has retained earnings
of $27,000, the stockholders’ equity section is as follows:
Hydro-Slide, Inc.
Balance Sheet (partial)
Stockholders’ equity
Paid-in-capital
Common Stock
Paid-in-capital in excess of par value
Total paid-in-capital
Retained earnings
Total stockholders’ equity
$2,000
4,000
6,000
27,000
$33,000
ISSUING NO-PAR
COMMON STOCK FOR CASH
If issue price > stated value, the
stated value is credited to common stock, and
the excess goes to paid-in excess of stated value.
If Hydro-Slide Inc. issues 5,000 shares of
$5 stated value no-par stock for $8 per share:
Date
1/1/xx
Account
Cash
Debit
Credit
40,000
Common Stock (5000 x $5)
25,000
Paid-in capital in excess of stated value
15,000
(record issuance of stated value, no par shares)
ISSUING NO-PAR
COMMON STOCK FOR CASH
If there is no stated value, proceeds
are credited to common stock.
If Hydro-Slide Inc. issues 5,000 shares of
no stated value stock for $8 per share:
Date
1/1/xx
Account
Cash
Common Stock
(record issuance of no-par shares)
Debit
Credit
40,000
40,000
ISSUING COMMON STOCK FOR
SERVICES OR NON-CASH ASSETS
COST IS:
FMV of consideration given up OR FMV of consideration received
whichever is more clearly determinable
Attorneys helped Jordan Company incorporate, and have billed $5,000
for services. The attorneys accept 4000 shares of $1 par value common
stock as payment. There is no established market price for the stock.
Date
1/1/xx
Account
Organization Expense
Debit
Credit
5,000
Common Stock
4,000
Paid-in capital in excess of par
1,000
(record issuance of stock to attorneys)
STUDY OBJECTIVE 3
ACCOUNTING FOR TREASURY STOCK
Treasury stock is a corporation's own stock
that has been reacquired but not retired.
Why do companies purchase treasury stock?
1) To reissue shares to officers or employees
2) To increase trading & enhance market value
3) To have additional shares to buy other companies
4) To reduce shares outstanding, and increase EPS
5) To avoid a takeover by disgruntled investors.
STOCKHOLDERS EQUITY SECTION
WITH NO TREASURY STOCK
Before the purchase of the treasury stock,
the stockholders’ equity is as follows:
Mead, Inc.
Balance Sheet (partial)
Stockholders’ equity
Paid -in capital
Common stock, $5 par, 10,000 shares
Issued and outstanding
Retained earnings
Total stockholders’ equity
$ 500,000
200,000
$ 700,000
PURCHASE OF TREASURY STOCK
If Mead, Inc. has 100,000 shares of $5 par value common stock
outstanding (all issued at par value) and it decides to acquire
4,000 shares of its stock at $8 per share, the entry is:
Date
Feb 1
Account
Treasury stock
Debit
Credit
32,000
Cash
32,000
(record purchase of treasury stock)
Cost method
STOCKHOLDERS EQUITY SECTION
WITH TREASURY STOCK
The acquisition of treasury stock REDUCES stockholders’ equity
The stockholders’ equity section of Mead, Inc. after
purchase of treasury stock is as follows:
Mead, Inc.
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital
Common stock, $5 par, 100,000 shares issued
and 96,000 shares outstanding
Retained earnings
Total paid-in capital and retained earnings
Less: Treasury stock (4,000 shares)
Total stockholders’ equity
$500,000
200,000
700,000
32,000
$668,000
DISPOSAL OF TREASURY
STOCK ABOVE COST
If 1,000 shares of treasury stock of Mead, Inc.,
previously acquired at $8 per share, are sold at $10 per
share on July 1. The entry is:
Date
Account
July 1 Cash
Debit
Credit
10,000
Treasury Stock
8,000
Paid-in capital from treasury stock
2,000
(record sale of treasury stock above cost)
The $2,000 credit is NOT A GAIN on Sale of Treasury Stock
DISPOSAL OF TREASURY
STOCK BELOW COST
If Mead, Inc. sells an additional 800 shares of treasury
stock on October 1 at $7 per share, the entry is:
Date
Oct 1
Account
Cash
Debit
Credit
5,600
Paid-in capital from treasury stock
800
Treasury stock
(record sale of treasury stock below cost)
The sale of treasury stock increases
TOTAL ASSETS and STOCKHOLDERS’ EQUITY
6,400
DEPLETING THE BALANCE IN
PAID-IN CAPITAL FROM TREASURY STOCK
If Mead, Inc., sells its remaining 2200 shares
at $7 per Share on December 1, the entry is:
Date
Dec 1
Account
Cash
Debit
15,400
Paid-in capital from treasury stock
1,200
Retained earnings
1,000
Treasury stock
Credit
17,600
(record sale of 2200 shares of treasury stock)
When the credit balance in paid-in capital from treasury stock is
depleted, the difference is debited to RETAINED EARNINGS.
STUDY OBJECTIVE 4
PREFERRED STOCK
Preferred stock has priority over common stock in terms of
Distribution of earnings
Assets in liquidation
No voting rights.
Identified separately from other stock and paid in capitals.
DIVIDEND PRFERENCES
CUMULATIVE DIVIDEND
Preferred stockholders must be paid both
current and prior year dividends before
common stockholders receive any dividends.
DIVIDENDS IN ARREARS
Preferred dividends not declared in a given period.
Not considered a liability, but disclosed
in the notes to the financial statements.
CUMULATIVE DIVIDEND
If Scientific-Leasing has 5,000 shares of 7%, $100 par value
cumulative preferred stock outstanding. The annual dividend
Is $35,000 (5,000 shares x $7 per share). If dividends are two
years in arrears, preferred stockholders should receive the
following before any dividends are paid to common stockholders.
Dividends in arrears ($35,000 x 2) $ 70,000
Current-year dividends
35,000
Total preferred dividends
$105,000
STUDY OBJECTIVE 5
CASH AND STOCK DIVIDENDS
Declaration Date
On December 1, 2006, Media General declares a 50 cents
per share dividend on 100,000 shares of $10 par value stock:
Date
Dec 1
Account
Retained earnings
Dividends payable
(declaration of a cash dividend)
Debit
Credit
50,000
50,000
STUDY OBJECTIVE 5
CASH AND STOCK DIVIDENDS
RECORD DATE
Date
Dec 30
Account
Debit
Credit
STUDY OBJECTIVE 5
CASH AND STOCK DIVIDENDS
PAYMENT DATE
On January 23, 2007, Media General
pays the previously declared dividend.
Date
Account
Jan 23 Dividends payable
Cash
(payment of cash dividend)
Debit
Credit
50,000
50,000
ALLOCATING CASH DIVIDENDS
BETWEEN PREFERRED AND COMMON
Assume that IBR Inc. has 1,000 shares of 8%, $100 par
cumulative preferred stock and 50,000 shares of $10 par
common stock outstanding at December 31, 2006.
If the Board of Directors declares a $6,000 cash
dividend on December 31, the entire amount will go
preferred stockholders because their annual
dividend is $8,000,(1,000 shares x $8) .
Date
Account
Dec 31 Retained earnings
Debit
Credit
6,000
Dividends payable
(payment of cash dividend)
Preferred dividends are now $2000 in arrears
6,000
ALLOCATING CASH DIVIDENDS
BETWEEN PREFERRED AND COMMON
Total dividend
$50,000
Allocated to preferred stock
•
•
Dividend in arrears, 2002 (1,000 x $2)
2006 dividend (1,000 x $8)
Remainder allocated to common stock
$2,000
8,000 10,000
$40,000
At December 31, 2007, IBR declares a $50,000 cash dividend.
The allocation of the dividend is shown above.
STOCK DIVIDENDS
A pro rata distribution of stock to existing stockholders.
Decreases retained earnings and increases in paid-in capital.
Small dividend (< 20%) valued at FMV
Large dividend (>20%) valued at Par/Stated
No effect on Total Assets or Stockholders’ Equity.
ENTRIES FOR STOCK DIVIDENDS
Medland Corporation has a balance of $300,000 in retained
earnings and declares a 10% stock dividend on its 50,000
shares of $10 par value common stock. The FMV of its
stock is $15 per share and the 5000 shares are issued.
The following entries would be made at the date of declaration:
Date
Declaration
Account
Retained earnings
Debit
Credit
75,000
Common stock dividends distributable
50,000
Paid-in capital in excess of par
25,000
(declaration of 10% stock dividend )
STATEMENT PRESENTATION
OF DIVIDENDS DISTRIBUTABLE
Common Stock Dividends Distributable is a stockholders’ equity account.
If a balance sheet is prepared before the dividend shares are issued,
the distributable account is reported in paid-in capital.
Paid-in capital
Common stock
500,000
Common stock dividends distributable
50,000
550,000
The following entry is made when the stock dividend is distributed.
Date
Account
distribution Common stock dividends distributable
Common stock
(distribution of 10% stock dividend )
Debit
Credit
50,000
50,000
STOCK DIVIDEND EFFECTS
Before
Dividend
After
Dividend
Stockholders’ equity
Paid-in capital
Common stock, $10 par
Paid-in capital in excess of par value
Total paid-in capital
Retained earnings
Total stockholders’ equity
Outstanding shares
$500,000 $550,000
0
25,000
500,000
575,000
300,000
225,000
$800,000 $800,000
50,000
55,000
Stock dividends change the composition of stockholders’ equity because
a portion of retained earnings is transferred to paid-in capital.
STOCK SPLITS
A multiple of existing shares issued to existing stockholders.
Total number of shares increases, par value decreases.
No effect on total stockholders’ equity.
No journal entry required.
STOCK SPLIT EFFECTS
Before
Split
After
Split
Stockholders’ equity
Paid-in capital
Common stock, $10 par
$500,000 $500,000
Paid-in capital in excess of par value
Total paid-in capital
Retained earnings
Total stockholders’ equity
Outstanding shares
0
0
500,000
500,000
300,000
300,000
$800,000 $800,000
50,000
2 for 1 stock split.
100,000
REVIEW QUESTION
Mickey Mouse Corporation has 450,000 shares
of $3 par value common stock outstanding.
If the company announces a 3 for 1 stock split, what
affect will this have on shares outstanding and par value?
Before split
After split
450,000 shares
1350,000 shares
$3.00 par value
$1.00 par value
What is the journal entry to reflect the stock split?
No journal entry required.
STUDY OBJECTIVE 6
RETAINED EARNINGS
Net income that is retained in the business.
Net losses reduce retained Earnings.
Net losses are not debited to paid-in capital accounts.
RETAINED EARNINGS
Net loss
Net income
Prior period adjustments (o)
Prior period adjustments (u)
Dividends
Some treasury stock disposals
STOCKHOLDERS’ EQUITY
WITH DEFICIT
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital
Common stock
Retained earnings (deficit)
Total stockholders’ equity
$800,000
(50,000)
$750,000
A debit balance in retained earnings is a DEFICIT.
RETAINED EARNINGS
RESTRICTIONS
Restrictions make a portion of the balance unavailable for dividends.
CAUSES
Legal
Restrictions
Contractual
Restrictions
Voluntary
Restrictions
(treasury stock)
(loan covenants)
(plant expansion)
PRIOR PERIOD ADJUSTMENTS
Correction of a material error in reporting
net income in previously issued financial statements. :
General Microwave understated 2005 depreciation expense
by $300,000. They discover the error in 2006,
and make the following corrective entry.
Date
2006
Account
Retained earnings
Accumulated depreciation
(adjust for PY understatement)
Debit
Credit
300,000
300,000
PRIOR PERIOD ADJUSTMENTS
A prior period adjustment is reported as an adjustment
to the opening balance of retained earnings:
General Microwave
Retained Earnings Statement (partial)
Balance, January 1. as reported
$800,000
Correction for prior period overstatement of net income
(depreciation error)
Balance, January 1, as adjusted
(300,000)
$500,000
STUDY OBJECTIVE 7
PRESENTATION & ANALYSIS
RETURN ON EQUITY
Measures how many dollars of net income were earned
For every dollar invested by common stockholders
Net income less
Average Common
preferred dividends
Stockholders Equity
Return on Common
=
Stockholders’ Equity
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