Chapter 11
Corporations: Organization, Stock
Transactions, Dividends, and
Retained Earnings
ACCT 100
Objectives of The Chapter
1. Basic characteristics of a corporation.
2. Accounting for issuance of common
stock and preferred stock.
3. Accounting for treasury stock.
4. Retained earning and dividends.
Stockholders' Equity
2
I. Corporations: An Overview




A form of business entity formed under
state law.
It is established as a legal entity
separated from its owners.
It has all rights as a person has except
for voting and holding public offices.
The owners of corporations have limited
liabilities.
Stockholders' Equity
3
Procedures of Forming a Corporation
1. Incorporators apply for a charter by
submitting articles of incorporation to
state officials.
2. If the application is approved, the state
will issue a charter.
 The corporation is formed upon the issuance of
the charter.
 A charter is a document to give legal status and
other rights to a corporation.
Stockholders' Equity
4
Procedures of Forming a Corporation
(contd.)
3. A stockholders’ meeting would be held
at which the initial issuance of capital
stock is made to the incorporators and
by-laws are developed.
A board of directors is elected.
4. Ready for operations.
5. Issuance of stock to public to raise more
capital (IPO).
Note: Regardless of the number of states in which a
corporation operating, it is incorporated in one state.
Stockholders' Equity
5
Organization of a Corporation
a. Stockholders (owners)
b. Board of directors; a chairperson is elected
among board of directors.
The board



decides major operation principles.
arranges major loans, authorize contracts.
appoints officers such as
CEO,COO,President, vice president.
c. Management (i.e., CEO,COO,etc.):

Responsible for day-to-day operations and
the preparations of the financial statements.
Stockholders' Equity
6
Advantages of a Corporation
1. Separated legal entity.
2. Stockholders have limited liability.
3. Continuous existence.
4. Ease of transfer of ownership.
5. Ease of capital generation.
6. Centralized authority and responsibility -to the president, not to numerous owners.
7. Professional management.
Stockholders' Equity
7
Disadvantages of a Corporation
1. Government regulations.
2. Corporation taxes (double taxation).
3. Separation of ownership and control:
principal & agent conflicts.
Stockholders' Equity
8
The Stockholders’
Equity
Section
of a
The Stockholders’
Equity
Section
Balance Sheet
of a Balance Sheet
Preferred stock, 7%, $100 par, 5,000 shares authorized,
700 shares issued
$ 70,000
Paid-in capital in excess of par -- preferred
7,000
Common stock, $10 par, 20,000 shares authorized,
6,500 shares issued
65,000
Paid-in capital in excess of par -- common
70,000
Retained earnings
95,000
Treasury stock -- common, 500 shares at cost (12,000)
Total Stockholders’ Equity
$295,000
_________
Stockholders' Equity
9
Terminology Related to
Stockholders’ Equity of a Corporation
1. Contributed Capital: the portion of
stockholders’ equity contributed by
investors through the issuance of stock.
2. Legal Capital (eliminated by Model
Business Corporation Act) : the
amount of contributed capital not
available for dividends.
Stockholders' Equity
10
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
3. Outstanding Stock: issued stock held
by investors.
4. Treasury Stock: issued stock
repurchased by the corporation and held
by the corporation, not retired.
5. Authorized Capital: The number of
shares of stock that the corporation may
issue as stated in its corporate charter.
Stockholders' Equity
11
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
6. Common Stock: A class of stock with
rights to share proportionately in:
(a) profits and losses;
(b) management (i.e., voting in corporate
matters, one share one vote);
(c) corporate assets in liquidation;
(d) any new issues of stock of the same
class (to maintain one’s proportionate ownership in
corporation).
Note: companies can have more than one class
of stock with differentStockholders'
rights. Equity
12
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
7. Preferred Stock: A class of stock with
some rights such as:
(a) Dividends (with a higher priority than
that of common stock);
(b) Sharing assets in liquidation (with
higher priority than that of common
stock).
Stockholders' Equity
13
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
8. Par Value Stock: Capital Stock with a
nominal dollar amount printed on the
stock certificate. In the past, most
states designate the par value of all
issued stock as the legal capital.
Stockholders' Equity
14
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
9. No-Par Stock: capital stock without a par
value. Many states allow the board of
directors to establish a stated value, as
the legal capital.
Since the concept of par value and legal
capital has been eliminated by Model
Business Corporation Act, the no-par-value
stock has gained its popularity.
Stockholders' Equity
15
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
 Examples of companies with no-parvalue stock: Nike, Procter & Gamble
and North American Van Lines (source:
Financial Accounting by Weygadt, etc.).
 However, there are companies which
issued par value stock prior to the
changes in the state law and continued
to issue previously authorized par value
shares.
Stockholders' Equity
16
Terminology Related to Stockholders’
Equity of a Corporation (contd.)
10. Stated Value: a nominal value
assigned to no-par stock by board of
directors.
11. Additional Paid-in Capital (or Paid-in
Capital in Excess of Par Value or
Premium on Capital Stock): the
excess of the issuance price over the
par value or the stated value.
Stockholders' Equity
17
2. Accounting for Issuance of Stock
a. Stock issued for cash
b. Stock issued for services or noncash
assets.
Stockholders' Equity
18
Stock Issued for Cash –common
stock with par value

Example 1: (See p539 of textbook for an
example of a stock certificate)
Issued 1,000 shares of $10 par common
stock for $50 per share.
Journal Entry
Cash
50,000
Common Stock
Paid-in Capital in Excess
of Par--Common Stock
Stockholders' Equity
10,000
40,000
19
Stock Issued for Cash (contd.)

Example 2: (Preferred Stock with Par)
Issued 1,000 shares of $10 par preferred
stock for $30 per share.
Journal Entry
Cash
30,000
Preferred Stock
10,000
Paid-in Capital in Excess
of par -- Preferred Stock
20,000
Stockholders' Equity
20
Stock Issued for Cash (contd.)
Example 3 (Common stock with stated value
set by the board of directors)
Issued 1,000 shares of no-par common
stock with a stated value $1 per share.
Shares are issued at $5 per share.
Journal Entry
Cash
5,000
Common Stock
1,000
Paid-in Capital in Excess
of Stated Value
4,000

Stockholders' Equity
21
Stock Issued for Cash (contd.)

Example 4 (No-par common stock
without stated value)
Issued 1,000 shares of no-par and no stated
value common stock for $5 per share.
Journal Entry
Cash
common Stock
5,000
5,000
Stockholders' Equity
22
Stock Issued for services or noncash
assets



Principle: Stock issued for service or
property should be recorded either at the fair
value of the stock or at the fair value of the
property, whichever is more clearly
determinable (reliable).
In most cases, if stock is traded frequently,
the fair value of stock is used.
Otherwise, use the market value of the
property.
Stockholders' Equity
23
Stock Issued for Noncash Proposition
(contd.)

Example: issued 1,000 shares of $5 par C.S.
for building. The market value of the stock is
$15 per share and is traded frequently.
Journal Entry:
Building
15,000
C.S.
5,000
Additional paid-in Capital
in excess of par -- C.S.
10,000
Stockholders' Equity
24
Preferred Stock Characteristics
1. Preference as to dividends: holders
have a preference to dividends.
2. The annual dividends are expressed
as percentage of the par value.
If no-par preferred stock is issued, the
dividend is expressed as a dollar
amount per share.
Stockholders' Equity
25
Preferred Stock Characteristics
(contd.)
3. A preference to dividends does not
guarantee a preferred dividend payment.
Dividend payment is at the discretion of the
board of directors.
4. If dividends are “passed” (not declared or
amounts declared less than the stated
dividends) in a year, a holder of non
cumulative preferred stockholder will never
be paid those dividends.
Stockholders' Equity
26
Cumulative Preferred Stock



However, the amount of passed dividends
becomes “dividends in arrears” for a
cumulative preferred stock.
Dividends in arrears accumulate from
period to period.
Dividends in arrear have the highest
priority to be paid in the future if dividends
were declared in the future.
Stockholders' Equity
27
Dividends Allocation: Examples
Year 1: Case I:
Dividends declared = $10,000
Com. STK shares outstanding: 10,000, @$5
Preferred STK outstanding : 5,000, @$10,
dividend is 6% of the par value
Dividends for P.S. = 6% *10*5,000= $3,000.
Dividends for C.S. = ($10,000-3,000)=$7,000.
Or $0.7 per share ($7,000/10,000 shares)
Stockholders' Equity
28
Dividends Allocation: (contd.)
Case II: Same information as in Case I except
that dividends declared = $1,000.
Dividends for P.S. = $1,000.
Div. Passed=$2,000
Dividends for C.S. = $0
If this is a cumulative P.S. the dividends in
arrears equal $2,000 ($3,000-1,000).
If this is a non-cumulative P.S., the $2,000 will
never been paid.
Stockholders' Equity
29
Dividends Allocation (contd.)
Case III:
Same information as in Case I except that
dividends declared = $500.
Dividends for P.S. = $500.
Dividends for C.S. = $0
If this is a cumulative P.S. the dividends in
arrears equal $2,500 ($3,000-500).
If this is a non-cumulative P.S., the $2,500 will
never been paid.
Stockholders' Equity
30
Dividends Allocation (Contd.)
Year 2: Continued from Case II of year 1,
assuming a cumulative preferred stock and
the dividends declared = $8,000.
Dividends for P.S. => $2,000 (div. In arrears)
$3,000 (div. Of year 2)
$ 5,000
Dividends for C.S. => $8,000- $2,000-3,000 =
$3,000
Stockholders' Equity
31
Convertible Preferred Stock (skip)

Convertible preferred stock allows
stockholders, at their option, under
specified conditions to convert the
shares of preferred stock into another
security of the corporation.
Stockholders' Equity
32
Accounting for Conversion of
Preferred to Common Stock (skip)
Book value method is used.
Example: A corporation issued 500 shares of $100
par convertible preferred stock at $120 per
share. If each preferred share is converted into
4 shares of $20 par common stock, the
following entry will be recorded:
Preferred Stock
50,000
Additional Paid-in Capital on P.S 10,000
Common Stock
40,000
Additional Paid-in capital
-- Common Stock Stockholders' Equity
20,00033
3. Treasury Stock



Treasury stock is issued stock that has
been purchased back (reacquired) by the
issuing corporation.
Treasury stock carries no voting or
preemptive rights, no right to dividends,
and no right at liquidation.
However, it does participate in stock split.
Stockholders' Equity
34
Treasury Stock (contd.)
Reasons of acquiring treasury stock:
1. To use for stock option, bonus and employee
purchase plans;
2. To use in the conversion of convertible preferred
stock or bonds;
3. To use excess cash and help maintain the
market price of its stock; to increase EPS;
4. To use in the acquisition of other companies;
5. To use for stock dividend;
6. To reduce the number of shares held by outside
shareholders and thereby reduce the likelihood
of being acquired by another company.
Stockholders' Equity
35
Accounting for Treasury Stock
(T.S.) –the Cost Method
Cost Method:
T.S. is recorded at cost paid for transactions:
1. Issuance of 6,000 shares of $10 par common
stock for $12 per share
Cash
72,000
C.S., $10 par
60,000
Additional Paid-in Capital
on C.S.
12,000
Stockholders' Equity
36
Accounting Methods for Treasury
Stock (T.S.) (contd.)
2. Reacquisition of 1,000 shares of C.S.
at $15 per share:
Treasury Stock
15,000
Cash
15,000
3. Reissuance of 600 shares of T.S.
at $17 per share:
Cash
10,200
T.S.
Additional Paid-in Capital
from T.S.
Stockholders' Equity
9,000
1,200
37
Accounting Methods for Treasury
Stock (T.S.) (contd.)
4. Reissuance of another 200 shares of T.S.
at $10 per share
Cash
Additional Paid-in Capital
from T.S.
Treasury Stock
Stockholders' Equity
2,000
1,000
3,000
38
Accounting Methods for Treasury
Stock (T.S.) (contd.)
5. Reissuance of another 100 shares of T.S.
at $8 per share
Cash
800
Additional Paid-in Capital fm T.S. 200
Retained Earning
500
Treasury Stock
1,500
Note: neither the purchase nor the sale of treasury
stock results in a gain or a loss. Sale of T.S. above
cost results in an increase in the paid-in capital while
sale of T.S. below the cost results in a decrease of
paid-in capital or retained earnings.
Stockholders' Equity
39
Balance Sheet Presentation of
Treasury Stock

The stockholders’ equity section is
prepared after transactions 1-5 as
follows:
(Assume retained earnings is $40,000
prior to recording any treasury stock
transactions)
Stockholders' Equity
40
Balance
Sheet
Presentation
Treasury
Balance
Sheet
Presentation
of TreasuryofStock
(contd)
Stock (contd)
Cost Method:
Contributed Capital:
Common stock, $10 par (20,000 shares authorized,
6,000 shares issued, of which
100 are being held as Treasury Stock)
$ 60,000
Additional paid-in capital on C.S.
12,000
Total Contributed Capital
72,000
Retained Earnings (see Note)
39,500
Total Contributed Capital and Retained Earnings 111,500
Less: Treasury Stock (100 shares at cost)
(1,500)
Total Stockholders’ Equity
$110,000
_________
Note: Retained Earnings are restricted regarding dividends in the
amount of $1,300, the cost of treasury stock.
Stockholders' Equity
41
Retirement of Stock
Continuing the treasury stock example:
6. Retirement of the last 100 shares of T.S.
Common Stock, $10 par
1,000
*Additional Paid-in
on Common Stock
200
Retained Earnings
300
Treasury Stock
1,500
*[12,000  (100 6,000)] = $200
Original additional Paid-in Capital on common
stock for 6,000 shares.
Stockholders' Equity
42
4. Retained Earnings and Dividends


The major components of stockholders’
equity are contributed capital and the
retained earnings.
Factors that affect retained earnings
besides net income (or net loss) include (1)
dividends, (2) prior period adjustments, (3)
appropriations (voluntary restrictions), and
(4) quasi-reorganizations.
Stockholders' Equity
43
Dividends


While the net income increases the
retained earnings, the distribution of
dividends reduces the retained
earnings.
In order to declare dividends, a
company must meet legal requirements
and must have assets available for
distribution.
Stockholders' Equity
44
Dividends (Contd.)
Most companies regard the unrestricted
retained earnings as the limit for dividends
distribution.
Restrictions of retained earnings include:
1) Legal restrictions: Many states require
corporations to restrict the cost of treasury
stock from dividends distribution.
2)Contractual restrictions: A long-term bond
contract may limit the use of assets for
payment of dividends ,
Stockholders' Equity
45
Dividends (Contd.)
3)Voluntary restrictions: Appropriation of
retained earnings for specific purposes.
 The board of directors is responsible for
the establishment of dividend policy
and the determination of the amount,
timing and types of dividends to be
declared.
Stockholders' Equity
46
Dividends (contd.)


A few types of dividends may be considered:
(1) cash, (2) property, (3) scrip, (4) stock, and
(5) liquidating dividends.
Cash, property and scrip dividends decrease
retained earnings (R/E) (and stockholders’
equity); stock dividends decrease R/E and
increase contributed capital by the same
amount; liquidating dividends decrease con
Stockholders' Equity
47
Cash Dividends

Cash dividend is the most common type of
dividend which is the distribution of cash by
the corporation to its stockholders.
Stockholders' Equity
48
Cash Dividends
Four dates are relevant to the cash
dividends:
 (1) the date of declaration,
 (2) the ex-dividend date (a few days before
the record date),
 (3) the date of record (a few weeks after
declaration date), and
 (4) the date of payment (2-4 weeks after
the date of record).

Stockholders' Equity
49
Example

On Nov. 3, 20x2, the board of directors
declares preferred dividends totaling
$10,000 and common dividends totally
$20,000. These dividends are payable on
12/15/x2 to stockholders of record on
11/24/x2. The ex-dividend date is
11/21/x2. The journal entries to record
the dividends are:
Stockholders' Equity
50
Example (contd.)
11/3/x2 (the date of declaration)
Retained Earnings
30,000
Dividends Payable: Common
20,000
Dividends Payable: Preferred
10,000
11/24/x2 (the date of record)
Memo: the company will pay dividends on 12/15/x2
to preferred and common stockholders of
record as of today, the date of record.
12/15/x2
Dividends Payable: Common stock 20,000
Dividends Payable: Preferred stock 10,000
Cash
30,000
Stockholders' Equity
51
Stock Dividends



A stock dividend is a proportional distribution
of additional shares of a corporations’ own
stock to its shareholders.
When a stock dividend is distributed, no
corporate assets are distributed.
Each stockholder maintains the same
percentage of ownership as before the stock
dividend.
Stockholders' Equity
52
Stock Dividends (contd.)


Small stock dividend is accounted for
by transferring an amount equals to the
fair market value of the additional
shares issued from retained earnings to
contributed capital.
Reasons of declaring a stock dividend:
to continue dividend but to conserve
cash.
Stockholders' Equity
53
Stock Dividends (contd.)


A small stock dividend is less than 20%
or 25% of outstanding shares.
For a large stock dividend, the
accounting treatment is only to
capitalize the par value of the stock.
Stockholders' Equity
54
Example 1: Small Stock Dividend

A Corporation with 20,000 shares
outstanding declares and issues a 10%
stock dividend. On the date of
declaration, the stock sells for $23 per
share with a par value of $10. The
2,000 share stock dividend is recorded
at the fair market value of $46,000 as
follows:
Stockholders' Equity
55
Example 1 (contd.)
Date of Declaration:
Retained Earnings
46,000
C.S. To be Distributed **
20,000
Additional Paid-in Capital
from Common Stock Dividend
26,000
Date of Issuance:
C.S. To be Distributed
20,000
C.S., $10 par
20,000
* There is no change in the stockholders’ equity before
and after the stock dividend.
** This account is Not a liability, but a temporary
stockholders’ equity item representing the legal capital
related to the stock to be issued. This account is
reported as a component of contributed capital.
Stockholders' Equity
56
Example 2: Large Stock Dividend

Assume that a corporation with 20,000
share outstanding declares a 40%
stock dividend when the stock is selling
for $23 per share with a par value of
$10 per share.
Stockholders' Equity
57
Example 2 (contd.)
Date of Declaration:
Paid in Capital
C.S to be Distributed
($10  20,000  40%)
80,000
Date of Issuance:
C.S to be Distributed
C.S, $10 par
80,000
80,000
80,000
* The stockholders’ equity remains the same
before and after the stock dividend.
Stockholders' Equity
58
Stock Splits


Reasons:
(1) To increase the marketability of stock by
decreasing the market value and par value
per share
(2) To increase the numbers of shares
outstanding
Example: a 2 for 1 proportionate stock split
Shares
Par
Market
Outstanding
value
Price
Before Split
1,000
$50
$120
After Split
a
b
c
Stockholders' Equity
59
Accounting for Stock Splits
(proportionate stock splits)
No entry for proportionate stock splits. A
memo is required.
The memo indicates the increase of shares
outstanding and the reduction of par value
proportionately.
Stock splits will not affect total paid-in
capital, retained earnings or total
stockholders’ equity.

Stockholders' Equity
60
Similarities and Differences Between Stock
Dividends and Stock Splits (Skip)
Similarities:
1. Both increase the number of shares
issued and outstanding. Both also
increase proportionately the number of
shares of stock owned per stockholder.
2. Both do not change the total cost of
stock owned or the total stockholders’
equity.
Stockholders' Equity
61
Stock Dividends and Stock Splits (contd.)
(Skip)
Differences:
 Stock
dividend shifts an amount from
retained earnings to contributed capital
with the par value per share unchanged.
A stock split does not change any
account balance but change the par
value per share. A stock split also
increases the number of shares of stock
authorized, issued and outstanding.
Stockholders' Equity
62
Accounting for Prior Years’ Errors
 The correction of an error in a
previously issued financial statement is
referred to as a prior period
adjustment.
 The correction is made to the retained
earnings as an adjustment to the
beginning balance of current year’s
retained earnings.
Stockholders' Equity
63
Prior Period Adjustment- An Example
•
•
•
•
•
Failure to record depreciation expense
of $5,000 in 20x7. This error was
discovered in 20x8.
20x8
Retained Earnings 5,000
Accumulated Depre. 5,000
(To adjust for understated depreciation
In 20x7)
Stockholders' Equity
64
Prior Period Adjustment- An
Example (contd.)
Presentation: (assuming a beginning balance
of $30,000 in retained earnings)
Statement of Retained Earnings (partial)
For the Year Ended 12/31/20x8
Retained Earnings, 1/1/2008
Prior Period Adjustment
$30,000
(5,000)
Adjusted retained earnings, 1/1/2008 $25,000
Stockholders' Equity
65
Different Values of Stock
1. Market value: the price of a stock for
which a person can buy or sell a share
of the stock in the stock market.
2. (Skip) Redemption value: applies only
to callable preferred stock.
Stockholders' Equity
66
Different Values of Stock (contd.)
 (skip) A corporation can redeem (pay to
retire) a callable preferred stock at a
predetermined price during a
predetermined period (i.e., after
1/1/2008).
 (skip)This predetermined price is the
redemption value of the callable
preferred stock.
Stockholders' Equity
67
Different Values of Stock (contd.)
3. (skip) Liquidation value: applies only to
preferred stock.
 (skip)This is the amount the corporation
agrees to pay the preferred stockholders
per share if the corporation liquidates.
 (skip)Dividends in arrears are added to
liquidation value.
Stockholders' Equity
68
Different Values of Stock (contd.)
4.Book value (BV): the amount of
stockholders’ equity for per share of stock.
For preferred stock: redemption value
per share plus dividends in arrears.
For common stock:
(Total stockholders’ equity - BV of prefer. stock)
Total common stock shares outstanding
Stockholders' Equity
69
Decision Making Ratio
Rate of Return on stockholders’ equity:
Rate of return on 1
=
common
stockholders’ equity
Net Income - Preferred dividends
Average common stockholders’
equity
Average Common stockholders’ equity = Average of (total
stockholders’ equity - preferred stockholders’ equity)
1. Measuring the earning power of common stockholders’ equity.
Stockholders' Equity
70