Chapter 15
Organization and Operation of Corporations
True / False Questions
A limited liability company is a corporation for professionals such as lawyers and
accountants.
FALSE
A corporation is a legal entity separate from its owners.
TRUE
Corporations can be either public or limited.
FALSE
A privately held corporation has a limited life because it is tied to the physical lives of its
owners.
FALSE
Shares are attractive to investors because shareholders are not liable for the corporation's
actions and debts and because shares are easily transferred.
TRUE
The income of a corporation is taxed twice, first as corporate income and then as personal
income to shareholders who receive cash dividends.
TRUE
An underwriter keeps shareholder records and prepares official lists of shareholders and
dividend payments.
FALSE
The shareholders can vote to pay themselves a dividend.
FALSE
15-1
The statement of changes in equity for a corporation shows both how retained earnings and
share capital have changed during the accounting period.
TRUE
Net incomes or losses are recorded in a share capital account.
FALSE
The equity of a corporation changes because of net income or losses, distributions of incomes
(dividends) and shareholder investments.
TRUE
The two main areas of the equity section of a corporation's balance sheet are contributed
capital and retained earnings.
TRUE
The equity section for the single proprietorship can be called owner's equity because the
equity belongs to the owner. The equity section can be called shareholders' equity for a
corporation because the equity belongs to a group of owners known as shareholders.
TRUE
Whether a business is organized as a corporation or as a proprietorship, the net income
reported on the income statement will be the same.
FALSE
The main differences between net income reported by a proprietorship and a corporation are
income tax expense and salaries paid to owners.
TRUE
Authorized shares are the total number of shares outstanding.
FALSE
When a corporation sells shares directly, it pays a brokerage house to issue the shares.
FALSE
A corporation can issue two general types of shares: common and preferred.
TRUE
15-2
Common shares usually carry a preference for dividends.
FALSE
Special rights for preferred shares may include a preference in receiving dividends and in the
distribution of assets if the corporation is liquidated.
TRUE
One of the preference rights for preferred shares is the right to vote.
FALSE
Cumulative preferred shares carry the right to be paid both current and all prior periods'
unpaid dividends before any dividends are paid to common shareholders.
TRUE
Shares are most commonly issued for cash.
TRUE
Organization costs may be paid for by giving shares to promoters of a corporation in
exchange for their services in organizing the corporation.
TRUE
Corporations issue preferred shares in order to raise capital without sacrificing control of the
corporation and to increase the return earned by common shareholders.
TRUE
The use of preferred shares to increase return to common shareholders is an example of
financial leverage.
TRUE
When preferred shares are issued, this will always cause an increase in the future return to
common shareholders.
FALSE
Preferred shares are seen by some investors as being less risky and having a greater dividend
rate than common shares.
TRUE
15-3
When issuing common shares the initial investment is credited to Common Shares.
TRUE
Unpaid preferred dividends are called dividends in arrears.
TRUE
The date of record is the date the directors vote to pay a dividend to shareholders.
FALSE
The declaration of cash dividends reduces retained earnings.
TRUE
Dividends represent the distribution of profits to the shareholders of a corporation.
TRUE
Dividends represent the distribution of profits to the managers of a corporation.
FALSE
Cumulative preferred shares have the right to be paid both current and prior periods' unpaid
dividends before any dividend is paid to common shareholders.
TRUE
Callable preferred shares give the shareholders the option of exchanging their preferred shares
into common shares at a specified rate.
FALSE
Multiple Choice Questions

The costs of bringing a corporation into existence, including legal fees, promoters'
fees, and amounts paid to the government are called:
A. Minimum legal capital.
B. Contributed capital.
C. Organization costs.
D. Financial leverage.
E. Prepaid expenses.
15-4

A proxy is:
A. A legal document that gives an agent of a shareholder the power to exercise the
voting rights of that shareholder's shares.
B. A contractual commitment by an investor to purchase unissued shares and become
a shareholder.
C. An amount of assets defined by law that shareholders must invest and leave
invested in a corporation.
D. The right of common shareholders to protect their proportionate interests in a
corporation by having the first opportunity to purchase additional shares of common
shares issued by the corporation.
E. An arbitrary value a corporation places on each of the corporation's shares.

Buying shares in a corporation is attractive to investors because:
A. Shareholders are not liable for the corporation's actions and debts.
B. Shares are easily transferred.
C. A corporation has unlimited life.
D. Shareholders are not agents of the corporation.
E. All of these answers are correct.

The category of equity for a corporation which represents the cumulative net incomes
less losses and dividends is called:
A. Contributed capital.
B. Preferred shares.
C. Retained earnings.
D. Financial leverage.
E. The income statement.

When a corporation issues only one class of shares they are:
A. Special shares.
B. Preferred shares.
C. Common shares.
D. Private shares.
E. Public shares.

The financial statement that shows the changes to a corporation's contributed capital is
called:
A. Balance Sheet
B. Statement of Changes in Equity
C. Income Statement
D. Statement of Contributed Capital
E. None of these answers is correct.
15-5

The accounting equation for a corporation is:
A. Assets = Equity + Liabilities
B. Assets - Liabilities = Equity
C. Assets = Liabilities + Equity
D. All of these answers are correct

The right of common shareholders to protect their proportionate interest in a
corporation by having the first opportunity to buy additional shares of common shares
issued by the corporation is called:
A. Preemptive right.
B. Proxy.
C. Right to call.
D. Financial leverage.
E. Voting right.

Common shares:
A. Represent residual equity in a corporation.
B. Always represent total contributed capital.
C. Allow shareholders to bind the corporation to contracts because they share in
ownership.
D. Make shareholders liable for acts of the corporation because they share in
ownership.
E. Are usually redeemable.

The total amount of shares that a corporation's charter allows it to issue is:
A. Authorized.
B. Issued.
C. Outstanding.
D. Common.
E. Preferred.

The total amount of cash and other assets received by a corporation from its
shareholders in exchange for common shares is included in:
A. Organization costs.
B. Private held shares.
C. Contributed capital.
D. Retained earnings.
E. Equity.
15-6

Legal costs incurred to get a corporation up and running should be accounted for by
debiting:
A. Retained earnings.
B. Share capital.
C. Organization costs.
D. Cash.
E. Common shares.

If a corporation that has only one class of shares, or if there is more than one class, the
class that has no preference over the other classes of shares, is:
A. Preferred shares.
B. Common shares.
C. Convertible preferred shares.
D. Cumulative preferred shares.
E. Participating preferred shares.

Owners of preferred shares often do not have:
A. Ownership rights to assets of the corporation.
B. Voting rights.
C. Preference to dividends.
D. The right to sell their shares.
E. Rights in liquidation.

A dividend preference for preferred shares means:
A. Preferred shareholders are allocated their dividends before any dividends are
allocated to common shareholders.
B. That preferred shareholders are guaranteed dividends.
C. That dividends are paid quarterly.
D. That only preferred shareholders will receive dividends.
E. All of these answers are correct.

Preferred shares may be issued instead of common shares:
A. To increase financial leverage.
B. To prevent dilution of voting ownership.
C. To appeal to investors who believe that common shares are too risky.
D. To increase the return earned by common shareholders.
E. All of these answers are correct.

All of the following are given as possible motivations for a corporation to issue
preferred shares except:
A. Raise capital with sacrificing voting control.
B. Increase the return of common shareholders.
C. Appeal to investors who do not want to invest in common shares.
D. If the preferred shares are convertible, they are more attractive to potential
investors.
E. Preferred dividends are paid before common dividends.
15-7

The payment of a dividend will reduce the following two accounts:
A. Common shares and cash
B. Cash and dividends payable.
C. Equity and retained earnings.
D. Retained earnings and dividends payable
E. Equity and cash

The date a board of directors votes to pay a dividend is:
A. The date of the annual shareholders meeting.
B. The date of declaration.
C. The date of record.
D. The date of payment.
E. The liquidating date.

Preferred shares that give the shareholders the option of exchanging their preferred
shares for common shares at a specified rate are known as:
A. Participating preferred shares.
B. Callable preferred shares.
C. Cumulative preferred shares.
D. Convertible preferred shares.
E. Noncumulative preferred shares.

A preferred share on which the right to receive dividends is lost for any year that the
dividends are not declared is a:
A. Participating preferred share.
B. Callable preferred share.
C. Cumulative preferred share.
D. Convertible preferred share.
E. Noncumulative preferred share.
15-8

Preferred shares that the issuing corporation, at its option, may retire by paying a
specified amount to the preferred shareholders plus any dividends in arrears are
called:
A. Convertible preferred shares.
B. Callable preferred shares.
C. Private shares.
D. Cumulative preferred shares.
E. Participating preferred shares.
Matching Questions
Match each of the following terms with the appropriate definition.
1. Organization costs
2. Noncumulative
preferred shares
3. Authorized shares
4. Callable preferred
shares
5. Preemptive right
6. Common shares
7. Convertible
preferred shares
8. Par value
The total amount of shares that a corporation's charter
authorizes it to sell.
Preferred shares that the issuing corporation, at its
option, may retire by paying a specified amount to the
preferred shareholder plus any dividends in arrears.
Preferred shares that give holders the option of
exchanging their preferred shares into common shares at
a specified rate.
A preferred share on which the right to receive
dividends is lost for any year that the dividends are not
declared.
Shares of a corporation that has only one class of
share.
The costs of bringing a corporation into existence,
including legal fees, promoters' fees, and amounts paid
to the government to secure the charter.
An arbitrary value a corporation places on each of the
corporation's shares.
The right of common shareholders to protect their
proportionate interest in a corporation by having the first
opportunity to buy additional common shares issued by
the corporation.
15-9
3
4
7
2
6
1
8
5
Match each of the following terms with the appropriate definition.
1. Convertible
preferred shares
The amount that must be paid to call and retire a preferred
share.
Preferred shares on which undeclared dividends
accumulate until they are paid; common shareholders cannot
receive a dividend until all cumulative dividends have been
2. Call price
paid.
Achieving an increased return on common shares by
paying dividends on preferred shares or interest on debt at a
rate that is less than the rate of return earned with the assets
3. Equity
invested in the corporation by the preferred shareholders or
financing
creditors.
4. Preferred share
The price at which shares are bought or sold.
5. Deficit
Obtaining capital, or money, by issuing shares.
Shares that give owners a priority status over common
6. Cumulative
shareholders in one or more ways, such as the payment of
preferred shares
dividends or the distribution of assets on liquidation.
7. Financial
Arises when a corporation has a debit (abnormal) balance
leverage
in retained earnings.
Preferred shares that give shareholders the option of
8. Market value
exchanging their preferred shares for common shares at a
per share
specified rate.
The total amount of cash and other assets received by the
9. Contributed
corporation from its shareholders in exchange for common
capital
and/or preferred shares.
15-10
2
6
7
8
3
4
5
1
9