Chapter 20
Corporate
Organization and
Capital Stock
Forms of Business Organization
Sole
proprietorship
Partnership
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Corporation
• Fewest in number
• Account for more
business transactions
than the other two
types combined
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What Is a Corporation?
• “An artificial being, invisible, intangible, and
existing only in contemplation of the law.”
—Chief Justice John Marshall, 1818
– A separate legal entity
– A continuous existence apart from that of its
owners (stockholders)
– It may (among other things):
• Own property
• Enter into contracts
• Sue or be sued in the court system
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Corporations
• Issue stock to
stockholders
• Carry out business
activities for the
purpose of making
profits
• Distribute profits to
owners
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Advantages of the Corporate Form
1. Limited liability
– The corporation is responsible for its own debt.
– The stockholder can lose only up to the amount of
his or her investment.
2. Ease of raising capital
– A corporation can issue stock to raise capital.
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Advantages of the Corporate Form (cont’d)
3. Ease of transferring ownership rights
– Ownership rights in a corporation are represented
by shares of stock.
– Stock can readily be transferred from one person to
another without the permission of other
stockholders.
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Advantages of the Corporate Form (cont’d)
4. Continuous existence
– The length of life of a corporation is stipulated in its
charter.
• When the charter expires, it may be renewed.
– The death, incapacity, or withdrawal of an owner
does not affect the life of the corporation.
5. No mutual agency
– Stockholders who are not officers do not have the
power to bind the corporation to contracts.
– Owners need not participate in management.
– The corporation is free to employ the managerial
talent it believes can best accomplish its objectives.
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Disadvantages of the
Corporate Form
1. Additional taxation
– Taxation of corporate income at two separate
points is called double taxation.
• First, the net income of the corporation is taxed because
the corporation is a separate entity.
• When the net income is distributed as dividends to
stockholders, it becomes part of the personal income of
the individual stockholder and is taxed a second time.
– The corporation must pay charter fees (fees paid
for the corporation’s right to exist).
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Disadvantages of the
Corporate Form (cont’d)
2. Government regulation
– States often regulate:
• The amount of net income that a corporation may retain
• The extent to which it may buy back its own stock
• The amount of real estate it may own
3. Lack of control by owners
– Corporate ownership is separated from the control
of operations.
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Formation of a Corporation
1. A person or persons applies for a charter.
2. The appropriate state official issues the charter.
Charter
Written permit, issued by a state government, for a
corporation to exist
State-approved articles of incorporation
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Articles of Incorporation
• Include the following information:
–
–
–
–
Name and legal address of the corporation
Nature of the business to be conducted
Amount and description of capital stock to be issued
Name(s) and address(es) of first governing body of
the corporation
• Must be accompanied by a charter fee, which is
based on the dollar amount of the maximum
stock investment as specified in the charter,
called authorized capital
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Some Definitions
Authorized Capital
– The maximum
number of shares
that may be issued
for each class of
stock (common and
preferred) as set
out in the charter
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Capital Stock
– General term
referring to shares
of ownership in a
corporation
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Some Definitions (cont’d)
Closely Held Corporation
– A corporation
having a relatively
small group of
owners
– Stockholders may
also be directors
and officers
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Public Corporation
– A corporation having
a large group of
owners with shares
traded on a stock
exchange or in overthe-counter markets
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What Are Organization Costs?
• Organization costs, debited as they are incurred
to Organization Expense, include:
–
–
–
–
–
Fees paid to the state
Attorneys’ fees
Promotional costs
Travel outlays
Costs of printing stock certificates
• Organization Expense appears on the income
statement as an Operating Expense.
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Stock Certificates
• Consecutively numbered documents giving
evidence of ownership in shares of stock
• Issued only when the stockholder has paid for
the shares in full
• May have stubs and be bound into a stock
certificate book
• Stubs list:
– Name of the owner
– Number of shares issued
– Date of issuance
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Transfer of Stock Ownership
1. Stockholder surrenders certificate.
2. Corporation cancels certificate and matching
stub.
3. Corporation issues one or more stock
certificates to the new owner(s).
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Maintaining Up-to-Date Records
• Corporation uses this information for:
– Notifying stockholders of annual meetings
– Preparing financial reports
– Paying dividends
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Structure of a Corporation
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Dividends
• Distributions of earnings of a corporation, in the
form of either cash or additional shares of stock
• Sources of dividends:
– Current year’s net income
– Retained earnings of prior years
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Preemptive Right
• A stockholder’s right to maintain the same
proportionate ownership in a corporation in the
future as he or she does originally, through the
privilege of subscribing to a new issue of stock
in the same proportion as her or his present
ownership
• Example:
Corporation's New Issue of Stock: 1,000
Present amt. of stock outstanding =
10,000 Ruth Allen’s proportional
share (2,000/10,000) =
1/5
Number of shares Ruth Allen owns
Right to subscribe to
before the new issue =
2,000 (1/5 x 1,000) =
200
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Stockholders’ Equity
• Stockholders’ equity is the owners’ equity
in a corporation.
– Also referred to as capital
• Assets – Liabilities = Stockholders’ Equity
• For a corporation, Capital Stock accounts
replace Owner’s Capital accounts in a sole
proprietorship.
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Retained Earnings Account
• A stockholders’ equity account representing
capital generated by the corporation’s earnings
that remain in the firm
• The amount by which net income exceeds
dividends paid over the life of the corporation
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Stockholders’ Equity Accounts
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Capital Stock
Issued Stock
– Stock issued by a corporation
– Stock actually in the possession
of stockholders (issued stock
less the number of shares
reacquired by the company)
– Outstanding Stock = Issued
Stock – Treasury Stock
Outstanding Stock
Treasury Stock
– A corporation’s own stock, which it has
issued and which was at one time
outstanding, that the firm reacquires
– Treasury Stock = Issued Stock –
Outstanding Stock
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Why Reacquire Treasury Stock?
Corporation may want to:
1. Reissue shares to officers/employees under
bonus and stock option compensation plans
2. Rid the company of disgruntled investors
3. Increase trading of company’s stock in the
securities market to enhance its market value
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Par-Value Stock Versus No-Par Stock
• Par-value stock
– Par-value stock is stock for which a uniform face
value is printed on the stock certificates.
– The face value indicates the amount per share to be
entered in the Capital Stock account.
– Preferred stock generally has a par value.
– Common stock may not always have a par value.
• No-par stock
– No-par stock has no value printed on the stock
certificates.
– A stated value indicates the amount per share to be
entered in the Capital Stock account.
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Stated Value
• The amount per share of no-par stock that is
recorded in the corporation’s stock accounts
• An amount designated by law as not subject to
withdrawal by stockholders
– The minimum stated value varies from state to state.
– In some states, the board of directors may choose a
stated value that is higher than the minimum required
by state law.
• Stock will not be issued at an amount below stated
value, since the stated value may be changed
during a meeting of the board of directors.
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Legal Capital
• Minimum capital stock investment that a
corporation must maintain
• Capital that is not subject to withdrawal by
stockholders except in liquidation
– Protects part of the corporate assets for the creditors
• Usually equals total par or stated value
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Common Stock
• Stock whose owners are paid dividends only
after owners of preferred stock have been paid
(residual share)
– Although the preferred stockholders are paid first,
the potential upside of common stock is that
dividends may be greater than preferred stock
dividends, which are set at a uniform rate.
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Rights of Common Stockholders
•
•
•
•
Elect board of directors
Receive dividends
Preemptive right
Share in distribution of assets
if corporation is liquidated
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What Is Preferred Stock?
• Preferred stock is stock whose holders are paid
dividends at a uniform rate before any dividends
are paid to holders of common stock.
– Dividends, if declared, consist of an established
percentage of par value per share of preferred stock.
• The holder of preferred stock also has
preference in the distribution of assets in the
event of a liquidation.
– Holders of preferred stock are paid off before
holders of common stock.
• In most circumstances, holders of preferred
stock do not have voting privileges.
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Four Types of Preferred Stock
1.
2.
3.
4.
1
2
3
4
Cumulative preferred stock
Noncumulative preferred stock
Participating preferred stock
Nonparticipating preferred stock
Possibilities for Preferred Stock
Noncumulative preferred and nonparticipating preferred
Participating preferred
Cumulative preferred
Cumulative preferred and participating preferred
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Cumulative Preferred Stock
• Preferred stock whose holders must be paid
accumulated dividends, or dividends in arrears,
before any dividends can be paid to holders of
common stock
– If the corporation does not pay dividends to the
cumulative preferred stockholders, it is obligated to
pay them at a later date (before the common
stockholders are paid).
• Dividends in arrears, or “passed” dividends
– Dividends that the firm has failed to pay in prior
years to the cumulative preferred stockholders
• Most common type of preferred stock
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Noncumulative Preferred Stock
• Noncumulative preferred stock is preferred stock
in which dividends in arrears do not accumulate.
• Once dividends are passed, they are gone forever.
• Preferred stock is assumed to be noncumulative
(and nonparticipating) unless otherwise stated.
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Participating Preferred Stock
• Preferred stock whose holders share in any extra
dividends distributed by the corporation after the
regular dividend has been paid to holders of
preferred stock and a stipulated dividend has
been paid to holders of common stock
• Provides for the possibility of dividends
(depending on profits and a declaration by the
board) above and beyond the uniform rate
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Nonparticipating Preferred Stock
• Nonparticipating preferred stock is stock in which
the dividends are limited to the regular rate.
• Preferred stock is assumed to be noncumulative
and nonparticipating unless otherwise stated.
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Issuing Stock at Par for Cash:
An Example
• The Rocky Mountain
Corporation is organized
on July 16 with authorized
capital of 4,000 shares of
$100-par preferred 8
percent stock and 20,000
shares of $50-par common
stock.
• On August 1, the company
issues 2,000 shares of
preferred 8 percent stock
at par and 10,000 shares
of common stock at par.
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Authorized Common Stock
Number of Shares
20,000
Par Value
$50.00
Authorized Preferred Stock
Number of Shares
4,000
Par Value
$100.00
Uniform Dividend Rate
8%
Stock Issuance Date
Common Stock
Preferred Stock
August 1
10,000
2,000
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Journal Entry and
T Accounts for Transaction
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Controlling Accounts
and Subsidiary Ledgers
Controlling Accounts
Subsidiary Ledger
• Capital stock accounts • Known as the
– Preferred 8 Percent
stockholders’ ledger
Stock
– Common Stock
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– Stock certificate book
or supplementary
record showing name
and address of each
stockholder and
number of shares
owned
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Issuing Stock at Par for
Noncash Assets: An Example
• On August 1, Rocky
Mountain Corporation
receives equipment, a
building, and land in
exchange for 5,420
shares of common
stock.
Authorized Common Stock
Number of Shares
20,000
Par Value
$50.00
Authorized Preferred Stock
Number of Shares
4,000
Par Value
$100.00
Uniform Dividend Rate
8%
Stock Issuance Date
Common Stock
Preferred Stock
August 1
5,420
0
Assets should be recorded at their fair market
values so that there is a realistic base on which to
calculate future depreciation.
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Journal Entry with Assets
Recorded at Fair Market Value
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Issuing Stock at Par for
Organization Costs: An Example
• On August 1, Rocky Mountain
Corporation issues 100 common
stock shares to its organizers in
exchange for their services in
organizing the corporation.
• In this case, the fair market
value of the service recorded
(Organization Expense) is not
determinable.
• Therefore, the current market
price of the stock on the date the
service was acquired is used as
the amount at which to record
the expense and the stock.
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Authorized Common Stock
Number of Shares
20,000
Par Value
$50.00
Authorized Preferred Stock
Number of Shares
4,000
Par Value
$100.00
Uniform Dividend Rate
8%
Stock Issuance Date
Common Stock
Preferred Stock
August 1
100
0
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Journal Entry for the Transaction
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Factors That Influence
the Issue Price of Stock
1. The earnings record, financial position, and
dividend record of the corporation
2. The potential for growth in earnings of the
corporation
3. The supply and demand for money for
investment purposes in the money market
as a whole
4. General business conditions and prospects
for the future
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Premiums and Discounts
• Premium
– The amount by which the issuing price of a stock
exceeds the par value
• Discount
– The amount by which the issuing price of a stock
falls below the par value
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Issuing Stock at a Premium
• When stock is issued for more than its par value,
the accountant must credit a premium account.
• When stock is issued for less than its par value,
the accountant must debit a discount account.
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Premium on Stock
• For par stock, the accountant records:
– Debit to Cash or other noncash asset
– Credit to the stock account for the par value
– Credit to Paid-in Capital in Excess of Par Value for
the difference between the amount received and the
par value
• Treated as an addition to stockholders’ equity
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Issuing Stock at a Premium:
An Example
McKay Corporation
issues 900 shares of
$100-par cumulative
preferred 9 percent
stock at $103 on July 1.
Preferred Stock
Number of Shares Issued
900
Par Value
$100.00
Uniform Dividend Rate
9%
Cumulative
Yes
Issue Price on July 1
$103.00
Calculations for a Premium
Cash
= Number of Shares Issued x Issue Price on July 1
900 x
$103.00 = $92,700.00
Preferred 9% Stock = Number of Shares Issued x Par Value
900 x
$100.00 = $90,000.00
Premium on
Preferred 9% Stock = Number of Shares Issued x Issue Price - Par
900 x
$3.00 = $2,700.00
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Journal Entry and
T Accounts for the Transaction
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Review T Accounts
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Premium on Stock
• For no-par stock with a stated value, the
accountant records:
– Debit to Cash or other noncash asset
– Credit to the stock account for the stated value amount
– Credit to Paid-in Capital in Excess of Stated Value for
the difference between the amount received and the
stated value
• Treated as an addition to stockholders’ equity
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Paid-in Capital
• Paid-in Capital is a caption on the balance sheet
listed immediately under Stockholders’ Equity.
• The Paid-in Capital section includes the Stock
accounts and their related Premium or Discount
accounts.
– For each account, the accountant records all the
relevant details, including:
•
•
•
•
Par value
Number of shares authorized
Number of shares issued
Whether or not the stock is cumulative or participating
(not whether it is noncumulative or nonparticipating)
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Paid-in Capital
• Paid-in Capital is a caption on the balance sheet
listed immediately under Stockholders’ Equity.
• The Paid-in Capital section includes the Stock
accounts and their related Premium or Discount
accounts.
– For each account, the accountant records all the
relevant details, including:
•
•
•
•
Par value
Number of shares authorized
Number of shares issued
Whether or not the stock is cumulative or participating (not
whether it is noncumulative or nonparticipating)
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Stockholders’ Equity
on the Balance Sheet
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No-Par Stock and Stated Value
• Advantages of no-par stock:
– May be issued without a discount contingent liability
– Prevents any misconception on the part of naïve
investors as to the value of the stock
• The stated value may be changed during a
meeting of the board of directors (the value
must be higher than the legal minimum required
by the state).
• No-par stock will not be issued at an amount
below the stated value.
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Journalize Entries for the
Issuance of No-Par Stock
• When no-par stock with a stated value is
issued, all the proceeds are credited to the
stock account.
• The entry credits a Paid-in Capital in Excess of
Stated Value account for amounts higher than
the stated value.
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Issuing Stock with Stated Value
• Total Security Corporation chooses a stated
value of $50 per share for its common stock.
• On June 20, Total Security Corporation issues
1,400 shares at $56 per share, receiving cash.
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Stock Subscriptions
• Sale of stock directly to investors on a
subscription contract (installment) basis
– The investor enters into a contract with the
corporation, promising to pay at a later date for a
specified number of shares at an agreed upon price.
– The corporation agrees to issue the shares when the
investor has paid for them in full.
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Recording Sale of Stock
on the Subscription Basis
• Debit Subscriptions Receivable (a current asset):
– Number of Shares × Subscription Price
• Credit Stock Subscribed (a Paid-in Capital
account):
– Number of Shares × Par or Stated Value
• For a difference between the subscription price
and par or stated value:
– For par stock, credit Paid-in Capital in Excess of Par
Value account.
– For stated value stock, credit Paid-in Capital in
Excess of Stated Value for a premium (no discounts
allowed).
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Recording Receipt of Payments for the
Sale of Stock on the Subscription Basis
• Debit Cash.
• Credit Subscriptions Receivable.
• When the subscription is paid in full
and the stock is issued:
– Debit a Stock Subscribed account.
– Credit a Stock account.
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Subscription Transactions:
No-Par Stock, Mariposa, Inc.
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T Accounts for Mariposa, Inc.
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Ledger Accounts for Common Stock
and Common Stock Subscribed
Be sure to list the number of shares in the item column!
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Controlling Accounts and Subsidiary
Ledgers for Subscribed Stock
• Investors finish paying for subscriptions at
different times.
• Stock is issued when the subscriber has paid
in full.
• Corporation must maintain an account for
each individual subscriber.
• Subsidiary ledger is known as the Stock
Subscribers’ Ledger.
– A record showing the name and address of each
stockholder and the number of shares owned
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Relationship Between Controlling
Accounts and Subsidiary Ledgers
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A Corporate Balance Sheet
• Refer to Figure 6 on page 770 in your textbook
for an example of the classified balance sheet
for a corporation.
• Note that the credit balance in Retained
Earnings represents a surplus.
• If the Retained Earnings account were a debit,
this would represent a deficit.
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Accounts and the Fundamental Accounting Equation
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