13-1
Chapter
13
McGraw-Hill/Irwin1
Accounting for
Corporations
© The McGraw-Hill Companies, Inc., 2006
13-2
Learning objectives

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Identify characteristics of corporations and their organization.
Describe the components of stockholders’ equity.
Explain characteristics of common and preferred stock.
Explain the form and content of a complete income
statement.
Explain the items reported in retained earnings.
Record the issuance of corporate stock.
Distribute dividends between common stock and preferred
stock.
Record transactions involving cash dividends.
Account for stock dividends and stock splits.
Record purchases and sales of treasury stock and the
retirement of stock.
© The McGraw-Hill Companies, Inc., 2006
McGraw-Hill/Irwin2
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Corporate Form of Organization
An entity
created by law.
Existence is
separate from
owners.
Has rights and
privileges.
McGraw-Hill/Irwin3
Privately Held
Ownership
can be
Publicly Held
© The McGraw-Hill Companies, Inc., 2006
13-4
Characteristics of Corporations
Advantages
 Separate Legal Entity
 Limited Liability of Stockholders
 Transferable Ownership Rights
 Continuous Life
 Stockholders Are Not Corporate Agents
 Ease of Capital Accumulation
Disadvantages
 Governmental Regulation
 Corporate Taxation
McGraw-Hill/Irwin4
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Organizing and Managing a Corporation
Stockholders
Board of Directors
President, Vice-President,
and Other Officers
Employees of the Corporation
McGraw-Hill/Irwin5
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Organizing and Managing a Corporation
Corporate Organization Chart
Ultimate
control.
Stockholders
Selected by a
vote of the
stockholders.
Board of Directors
Stockholders
usually meet
once a year.
Overall
responsibility
for managing
the company.
President
Secretary
McGraw-Hill/Irwin6
Vice President
Finance
Vice President
Production
Vice President
Marketing
© The McGraw-Hill Companies, Inc., 2006
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Rights of Stockholders
Vote at stockholders’ meetings.
Sell stock.
Purchase additional shares of stock.
Receive dividends, if any.
Share equally in any assets remaining
after creditors are paid in a liquidation.
McGraw-Hill/Irwin7
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Stock Certificates and Transfer
When the stock is sold, the stockholder signs a
transfer endorsement on the back of the stock
certificate.
Each unit of ownership is called a share of stock.
A stock certificate serves as proof that a
stockholder has purchased shares.
McGraw-Hill/Irwin8
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Basics of Capital Stock
Total amount of stock that a
corporation’s charter authorizes it to sell.
Stockholders' Equity
Common Stock, par value $.01;
authorized 250,000,000 shares; issued
92,556,295 shares in 2005; 111,015,133
shares in 2004
McGraw-Hill/Irwin9
2005
$925,563
2004
$1,110,151
© The McGraw-Hill Companies, Inc., 2006
13-10
Basics of Capital Stock
Total amount of stock that has been
issued to stockholders.
Stockholders' Equity
Common Stock, par value $.01;
authorized 250,000,000 shares; issued
92,556,295 shares in 2005; 111,015,133
shares in 2004
McGraw-Hill/Irwin10
2005
$925,563
2004
$1,110,151
© The McGraw-Hill Companies, Inc., 2006
13-11
Selling (Issuing) Stock
Par value is an
arbitrary amount
assigned to each
share of stock when
it is authorized.
McGraw-Hill/Irwin11

Market price is the
amount that each
share of stock will
sell for in the market.
© The McGraw-Hill Companies, Inc., 2006
13-12
Issuing Par Value Stock
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Record:
1. The cash received.
2. The number of shares issued × the par value
per share in the Common Stock account.
3. The remainder is assigned to Contributed
Capital in Excess of Par.
McGraw-Hill/Irwin12
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Issuing Par Value Stock
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for $25 per share.
Let’s record this transaction.
Sept. 1 Cash
2,500,000
Common stock, $2 par value
Contributed capital in
excess of par value
200,000
2,300,000
Sold and issued 100,000 shares of common stock
McGraw-Hill/Irwin13
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13-14
Issuing Par Value Stock
Stockholders' Equity with Common Stock
Stockholders' Equity
Contributed capital:
Common Stock - $2 par value; 500,000 shares
authorized; 100,000 shares issued and
outstanding
$ 200,000
Contributed Capital in Excess of Par
2,300,000
Retained earnings
650,000
Total stockholders' equity
$ 3,150,000
McGraw-Hill/Irwin14
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Issuing Stock for Noncash Assets
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
Record:
1. The asset received at its market value.
2. The number of shares issued × the par value
per share in the Common Stock account.
3. The remainder is assigned to Contributed
Capital in Excess of Par.
McGraw-Hill/Irwin15
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Issuing Stock for Noncash Assets
Par Value Stock
On September 1, Matrix, Inc. issued 100,000
shares of $2 par value stock for land valued at
$2,500,000. Let’s record this transaction.
Sept. 1 Land
2,500,000
Common stock, $2 par value
Contributed capital in
excess of par value
200,000
2,300,000
Exchanges 100,000 common shares for land
McGraw-Hill/Irwin16
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Preferred Stock
A separate class of stock, typically having priority
over common shares in . . .
 Dividend distributions.
 Distribution of assets in case of liquidation.
Usually has a stated
dividend rate.
Normally has no
voting rights.
Corporations
with no
Preferred Stock
Corporations
with Preferred
Stock
73%
McGraw-Hill/Irwin17
27%
© The McGraw-Hill Companies, Inc., 2006
13-18
Preferred Stock
 Dillon Snowboards issues 50 shares of $100
par value preferred stock for $6,000 cash on
July 1, 2005.
 Dr. Cash
6,000
Cr. Preferred Stock, $100 par value 5,000
Cr. Contributed Capital in Excess
of par value, preferred stock
1,000
McGraw-Hill/Irwin18
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Reasons for Issuing Preferred Stock
 To raise capital without sacrificing
control.
 To appeal to investors who may believe
the common stock is too risky or that
the expected return on common stock is
too low.
McGraw-Hill/Irwin19
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13-20
Cash Dividends
To pay a cash
dividend the
corporation must
have:
1. A sufficient
balance in retained
earnings and
2. The cash
necessary to pay
the dividend.
McGraw-Hill/Irwin20
Cash Dividend Types and Frequency
100%
80%
73%
60%
40%
23%
20%
0%
Common
Preferred
© The McGraw-Hill Companies, Inc., 2006
13-21
Cash Dividends
Regular cash dividends provide a return to
investors and almost always affect the
stock’s market value.
June
30
Stockholders
Corporation
Dividends
McGraw-Hill/Irwin21
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13-22
Entries for Cash Dividends
Three important dates
Date of Declaration
Date of Record
Date of Payment
Record liability
for dividend.
No entry
required.
Record payment of
cash to stockholders.
McGraw-Hill/Irwin22
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Entries for Cash Dividends
On January 19, a $1 per share cash
dividend is declared on Dana, Inc.’s
10,000 common shares outstanding.
The dividend will be paid on March 19 to
stockholders of record on February 19.
Jan. 19 Retained earnings
10,000
Common dividend payable
10,000
Declared $1 per share cash dividend
Date of Declaration
Record liability
for dividend.
McGraw-Hill/Irwin23
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Entries for Cash Dividends
On January 19, a $1 per share cash
dividend is declared on Dana, Inc.’s
10,000 common shares outstanding.
The dividend will be paid on March 19 to
stockholders of record on February 19.
Date of Record
No entry required on
February 19.
No entry
required.
McGraw-Hill/Irwin24
© The McGraw-Hill Companies, Inc., 2006
13-25
Entries for Cash Dividends
On January 19, a $1 per share cash
dividend is declared on Dana, Inc.’s
10,000 common shares outstanding.
The dividend will be paid on March 19 to
stockholders of record on February 19.
Mar. 19
Common dividend payable
Cash
10,000
10,000
Paid $1 per share cash dividend
Date of Payment
Record payment of
cash to stockholders.
McGraw-Hill/Irwin25
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Deficits and Cash Dividends
Created when a company incurs cumulative losses
or pays dividends greater than total profits earned
in other years.
Dana, Inc.
Stockholders' Equity
December 31, 2005
Stockholders' Equity
Common stock $10 par value,
10,000 shares authorized and outstanding
Retained earnings deficit
Total stockholders' equity
McGraw-Hill/Irwin26
$ 100,000
(8,500)
$ 91,500
© The McGraw-Hill Companies, Inc., 2006
13-27
Stock Dividends
The corporation distributes additional shares of
its own stock to its stockholders without
receiving any payment in return.
Why a stock dividend?
100
Shares
100 shares
HotAir, Inc.
Common Stock
•Can be used to keep the market
price on the stock affordable.
$1 par
$1 par value
•Can provide evidence of
management’s confidence that
Stockholders
the company is doing well.
McGraw-Hill/Irwin27
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Stock Dividends
 A company has 1,000 common shares
outstanding. Market price is $12. The company
announces a 20% stock dividend. The market
price will be $10. However, due to the
expectation of future more cash dividend, the
market price may increase to 10.5 or so.
McGraw-Hill/Irwin28
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Stock Dividends
Small Stock Dividend
Distribution is  25% of the previously
outstanding shares.
Capitalize retained earnings for the market
value of the shares to be distributed.
Large Stock Dividend
Distribution is > 25% of the previously
outstanding shares.
Capitalize retained earnings for the minimum
amount required by state law, usually par or
stated value of the shares.
© The McGraw-Hill Companies, Inc., 2006
McGraw-Hill/Irwin29
13-30
Recording a Small Stock Dividend
Here is the stockholders’ equity section
of Quest’s balance sheet prior to the
declaration of a small stock dividend.
Quest, Inc.
Stockholders' Equity
December 31, 2005
Common stock - $1 par value,
250,000 shares authorized,
100,000 shares issued and outstanding
Contributed capital in excess of par value
Total contributed capital
Retained earnings
Total stockholders' equity
McGraw-Hill/Irwin30
$
$
$
100,000
8,000
108,000
35,000
143,000
© The McGraw-Hill Companies, Inc., 2006
13-31
Recording a Small Stock Dividend
On December 31, 2005, Quest declared a 2%
stock dividend, when the stock was selling for
$10 per share. The stock will be distributed to
stockholders on January 20, 2006. Let’s make
the December 31 entry.
Dec. 31 Retained earnings
Common stock dividend
distributable
Contributed capital in
excess of par value
20,000
2,000
18,000
Declared a 2,000 shares (2%) stock dividend
100,000 × 2% = 2,000 × $10 = $20,000/ 10000*.02=2000shares
2,000 × $1 par = $2,000/2000*$10=20000RE, 2000*$1=2000
McGraw-Hill/Irwin31
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Quest, Inc.
Stockholders' Equity
December 31, 2005
Before the
stock
dividend.
Common stock - $1 par value,
250,000 shares authorized,
100,000 shares issued and outstanding
Contributed capital in excess of par value
Total contributed capital
Retained earnings
Total stockholders' equity
$
$
$
100,000
8,000
108,000
35,000
143,000
Quest, Inc.
Stockholders' Equity
December 31, 2005
Common stock - $1 par value,
250,000 shares authorized,
100,000 shares issued and outstanding
Common stock distributable, 2,000 shares
Total common stock issued and to be issued
Contributed capital in excess of par value
Total contributed capital
Retained earnings
Total stockholders' equity
McGraw-Hill/Irwin32
$ 100,000
2,000
$ 102,000
26,000
$ 128,000
15,000
$ 143,000
After the
stock
dividend.
© The McGraw-Hill Companies, Inc., 2006
13-33
Recording a Large Stock Dividend
Router, Inc. shows the following
stockholders’ equity section just prior to
issuing a large stock dividend.
Router, Inc.
Stockholders' Equity
December 31, 2005
Common stock - $1 par value,
200,000 shares authorized,
50,000 shares issued and outstanding
Contributed capital in excess of par value
Total contributed capital
Retained earnings
Total stockholders' equity
McGraw-Hill/Irwin33
$
$
50,000
75,000
125,000
100,000
225,000
© The McGraw-Hill Companies, Inc., 2006
13-34
Recording a Large Stock Dividend
On December 31, 2005, Router declared a 40%
stock dividend, when the stock was selling
for $8 per share. State law requires that
large stock dividends be capitalized at par
value per share.
Dec. 31 Retained earnings
Common stock dividend
distributable
20,000
20,000
Declared a 20,000 shares (40%) stock dividend
50,000 × 40% = 20,000 shares × $1 par value = $20,000
McGraw-Hill/Irwin34
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Stock Splits
A distribution of additional shares of stock to
stockholders according to their percent
ownership.
$10 par value
Common Stock
Old
Shares
100 shares
$5 par value
New
Shares
Common Stock
200 shares
McGraw-Hill/Irwin35
© The McGraw-Hill Companies, Inc., 2006
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Stock Splits
Thomas, Inc. has the following stockholders’
equity section just prior to a 2-for-1 stock split.
Thomas, Inc.
Stockholders' Equity
June 30, 2005
Common stock - $10 par value,
100,000 shares authorized,
25,000 shares issued and outstanding
Contributed capital in excess of par value
Total contributed capital
Retained earnings
Total stockholders' equity
McGraw-Hill/Irwin36
$
250,000
300,000
550,000
775,000
$ 1,325,000
© The McGraw-Hill Companies, Inc., 2006
13-37
Stock Splits
After the 2-for-1 split the stockholders’ equity section
of the balance sheet looks like this . . .
Thomas, Inc.
Stockholders' Equity
June 30, 2005
No accounting
entry is made.
Common stock - $5 par value,
100,000 shares authorized,
50,000 shares issued and outstanding
Contributed capital in excess of par value
Total contributed capital
Retained earnings
Total stockholders' equity
McGraw-Hill/Irwin37
$
250,000
300,000
550,000
775,000
$ 1,325,000
© The McGraw-Hill Companies, Inc., 2006
13-38
Stock Splits
 The split does not affect any equity amounts
reported on balance sheet or any individual
stockholder’s percent ownership. Both the
contributed capital and retained earnings
accounts are unchanged by a split.
McGraw-Hill/Irwin38
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Treasury Stock
Corporations acquire shares of their own stock.
Why would a
company do
that?
Use the shares to acquire
control of another corporation.
To avoid a hostile takeover.
Use the shares for
employee stock options.
To maintain a strong market for
its stock or show management
confidence in the current price.
McGraw-Hill/Irwin39
© The McGraw-Hill Companies, Inc., 2006
13-40
Treasury Stock
Corporations and Treasury Stock
No Treasury Stock
38%
With Treasury
Stock
62%
McGraw-Hill/Irwin40
© The McGraw-Hill Companies, Inc., 2006
13-41
Purchasing Treasury Stock
On May 8, Whitt, Inc. purchased 2,000 of its
own shares of stock in the open market for
$8,000.
May 8
Treasury stock, common
Cash
8,000
8,000
Purchase 2,000 treasury shares at $4 per share
Treasury stock is shown as a reduction in total
stockholders’ equity on the balance sheet.
McGraw-Hill/Irwin41
© The McGraw-Hill Companies, Inc., 2006
13-42
Selling Treasury Stock at Cost
On June 30, Whitt sold 100 shares of its
treasury stock for $4 per share.
June 30
Cash
400
Treasury stock, common
400
Sold 100 shares of treasury for $4 per share
$8,000 ÷ 2,000 shares = $4 cost per treasury share
McGraw-Hill/Irwin42
© The McGraw-Hill Companies, Inc., 2006
13-43
Selling Treasury Stock Above Cost
On July 19, Whitt, Inc. sold an additional 500
shares of its treasury stock for $8 per
share.
July 19
Cash
4,000
Treasury stock,
Contributed capital,
treasury stock
2,000
2,000
Sold 500 treasury shares for $8 per share
Shares Per Share Total
Sale
500 $
8.00 $ 4,000
Cost
500
4.00
2,000
Contributed capital
$ 2,000
McGraw-Hill/Irwin43
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Selling Treasury Stock Below Cost
On August 27, Whitt sold an additional 400
shares of its treasury stock for $1.50 per
share.
Aug. 27
Cash
Contributed capital,
treasury stock
Treasury stock,
600
1,000
1,600
Sold 500 treasury shares for $1.50 per share
Shares Per Share Total
Cost
400 $
4.00 $ 1,600
Sale
400
1.50
600
Difference
$ 1,000
McGraw-Hill/Irwin44
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Reporting Income and Equity
Extraordinary
Items
Discontinued
Segments
Continuing
Operations
McGraw-Hill/Irwin45
Changes in
Accounting
Principle
Net Income
© The McGraw-Hill Companies, Inc., 2006
13-46
Continuing Operations
Revenues, expenses
and income generated
by the company’s
continuing operations.
Continuing
Operations
McGraw-Hill/Irwin46
Net Income
© The McGraw-Hill Companies, Inc., 2006
13-47
Discontinued Segments
Income from operating the discontinued segment prior
to its disposal and gain or loss on the sale of the net
assets of the segment.
Discontinued
Segments
Net Income
McGraw-Hill/Irwin47
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Extraordinary Items
Extraordinary
Items
A gain or loss that
is unusual in nature
and infrequent in
occurrence.
McGraw-Hill/Irwin48
Net Income
© The McGraw-Hill Companies, Inc., 2006
13-49
Changes in Accounting Principles
The increase or
decrease in income
when changing from
one generally accepted
accounting principle to
another.
Changes in
Accounting
Principle
Net Income
McGraw-Hill/Irwin49
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13-50
Income Statement
Campus, Inc.
Partial Income Statement
For Year Ended December 31, 2005
Income from continuing operations
Discontinued operations:
Income from operating Radio Division (net
of $105,000 income taxes)
$ 420,000
Loss on disposal of Radio Division (net of
$38,500 tax benefit)
(154,000)
Extraordinary Item:
Loss from earthquake damage (net of
$157,500 tax benefit)
Cumulative effect of a change in accounting principle:
Effect on prior years' income of changing
to a different depreciation method (net of
$12,000 income taxes)
Net income
McGraw-Hill/Irwin50
$ 1,389,500
266,000
(630,000)
48,000
$ 1,073,500
© The McGraw-Hill Companies, Inc., 2006
13-51
Earnings Per Share
Earnings per share is one of the most widely
cited items of accounting information.
Basic
Net income - Preferred dividends
earnings =
Weighted-average common shares outstanding
per share
McGraw-Hill/Irwin51
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13-52
Changes in Shares Outstanding
Derby, Inc. reports net income of $75,000 and
paid preferred dividends of $10,000 during
2005. The company started the year with
10,000 shares of common stock outstanding.
Derby sold an additional 4,000 share of stock
on March 31, and purchased 2,000 treasury
shares on September 30, 2005.
Date
Transaction
1/1/05
Balance
Sales of shares
3/31/05
Outstanding
Shares
Weighted
Average
10,000
3
2,500
14,000
6
7,000
3
3,000
12,500
Treasury shares
9/30/05
12,000
Weighted-average common shares outstanding
McGraw-Hill/Irwin52
Fraction of
Year
/12
/12
/12
© The McGraw-Hill Companies, Inc., 2006
13-53
Changes in Shares Outstanding
Derby, Inc. reports net income of $75,000 and
paid preferred dividends of $10,000 during
2005. The company started the year with
10,000 shares of common stock outstanding.
Derby sold an additional 4,000 share of stock
on March 31, and purchased 2,000 treasury
shares on September 30, 2005.
EPS =
McGraw-Hill/Irwin53
$75,000 - $10,000
12,500
= $5.20
© The McGraw-Hill Companies, Inc., 2006
13-54
Stock Options
The right to purchase common stock at a fixed
price over a specified period of time. As the
stock’s price rises above the fixed option
price, the value of the option increases.
Option
purchase
price $30
per share.
McGraw-Hill/Irwin54
Market
price of
stock $75
per share.
© The McGraw-Hill Companies, Inc., 2006
13-55
Stock Options
Options are given to key employees to
motivate them to:
 focus on company performance,
 take a long-run perspective, and
 remain with the company.
McGraw-Hill/Irwin55
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McGraw-Hill/Irwin56
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Statement of Retained Earnings
Total cumulative amount of reported net income
less any net losses and dividends declared
since the company started operating.
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2005
Retained earnings, 1/1/05
McGraw-Hill/Irwin57
$
875,000
Plus: net income
155,600
Less: dividends declared
Retained earnings, 12/31/05
(80,000)
950,600
$
© The McGraw-Hill Companies, Inc., 2006
13-58
Restricted Retained Earnings
Legal
Contractual
Most states restrict
the amount of
treasury stock
purchases to the
amount of retained
earnings.
Loan agreements
can include
restrictions on
paying
dividends below a
certain amount of
retained earnings.
McGraw-Hill/Irwin58
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Appropriated Retained Earnings
A corporation’s directors can voluntarily limit
dividends because of a special need for cash
such as the purchase of new facilities.
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2005
Retained earnings, 1/1/05
McGraw-Hill/Irwin59
$
875,000
Plus: net income
155,600
Less: dividends declared
(80,000)
Retained earnings, 12/31/05
$
950,600
Appropriated retained earnings
Unappropriated retained earnings
(450,000)
$ 500,600
© The McGraw-Hill Companies, Inc., 2006
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Prior Period Adjustments
Correction of material errors in past years’
financial statements. If an amount is incorrectly
expensed, add amount to Retained Earnings.
Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2005
Retained earnings, 1/1/05, as previously reported
Prior period adjustment: Cost of equipment
incorrectly expensed (net of $28,000 income taxes)
$
875,000
72,000
Retained earnings, 1/1/05, as adjusted
947,000
Plus: net income
155,600
Less: dividends declared
Retained earnings, 12/31/05
McGraw-Hill/Irwin60
(80,000)
$ 1,022,600
© The McGraw-Hill Companies, Inc., 2006
13-61
Statement of Stockholders’ Equity
Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2005
Common stock and
(In millions)
capital in excess of par
Shares
Amount
Balance at January 1, 2005
821
$
2,500
Stock sales
17
500
Stock repurchases and retirement
(17)
(260)
Cash dividends declared
Other, net
Net income
Balance at December 31, 2005
821
$
2,740
Retained
Earnings
$ 9,500
(925)
(150)
70
5,100
$ 13,595
Total
$ 12,000
500
(1,185)
(150)
70
5,100
$ 16,335
This is a more inclusive statement than the statement of
retained earnings.
McGraw-Hill/Irwin61
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Book Value per Share—Common
Records amount of stockholders’ equity
applicable to common shares on a per
share basis.
Stockholders’ equity applicable
to common shares
Book value per
=
Number of common shares
common share
outstanding
McGraw-Hill/Irwin62
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Book Value per Share—Preferred
Records amount of stockholders’ equity
applicable to preferred shares on a per
share basis.
Stockholders’ equity applicable
to preferred shares
Book value per
=
Number of preferred shares
preferred share
outstanding
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Dividend Yield
Tells us the annual amount of cash dividends
distributed to common stockholders relative to
the stock’s market price.
Dividend
=
Yield
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Annual cash dividends per share
Market value per share
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Price Earnings
This ratio reveals information about the stock market’s
expectations for a company’s future growth in
earnings, dividends, and opportunities.
PriceMarket value per share
=
Earnings
Earnings per share
If earnings go up,
will the market price
of my stock follow?
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Homework for Chapter 13
 Ex 13-16, 13-17
 Problem 13-2A, 13-4A
 Due on July 12, 2006 (Wednesday)
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End of Chapter 13
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