Financial accounting 9th kieso kimmel chapter 11

Advantages Disadvantages Characteristics of an Organization  Limited Liability of Stockholders  Ability to Acquire Capital... Characteristics of an Organization  Limited Liability of

Preview of Chapter 1

Financial Accounting

Preview of Chapter 11

Financial Accounting

Ninth Edition

Learning Objectives

After studying this chapter, you should be able to:

[1] Identify the major characteristics of a corporation.

[2] Record the issuance of common stock.

[3] Explain the accounting for treasury stock.

[4] Differentiate preferred stock from common stock.

[5] Prepare the entries for cash dividends and stock dividends.

[6] Identify the items reported in a retained earnings statement.

[7] Prepare and analyze a comprehensive stockholders’ equity section.

11 Corporations: Organization, Stock Transactions, Dividends,

and Retained Earnings

An entity separate and distinct from its owners.

Characteristics that distinguish corporations from

proprietorships and partnerships

Advantages

Disadvantages

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Corporation acts under its own name rather than in the name of its

stockholders

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Limited to their investment.

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Shareholders may sell their stock.

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Corporation can obtain capital through the issuance

of stock

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Continuance as a going concern is not affected by the

withdrawal, death, or incapacity of a

stockholder, employee, or officer

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Separation of ownership and management often reduces an owner’s ability to actively manage the

company

Characteristics that distinguish corporations

from proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

 Separate Legal Existence

 Limited Liability of Stockholders

 Ability to Acquire Capital

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

Characteristics that distinguish corporations from

proprietorships and partnerships

Characteristics of an Organization

 Limited Liability of Stockholders

 Ability to Acquire Capital

Corporations pay income taxes as a separate legal entity and in addition,

stockholders pay taxes on cash

Chairman and Board of Directors

President and Chief Executive Officer

General

Counsel/

Secretary

Vice President Marketing

Vice President Finance/Chief Financial Officer

Vice President Operations

Vice President Human Resources

Forming a Corporation

 File application with the Secretary of State

 State grants charter

Initial Steps:

Companies generally incorporate in a state whose laws are

favorable to the corporate form of business (Delaware, New Jersey).

Corporations engaged in interstate commerce must obtain a license

from each state in which they do business.

The Corporate Form of Organization

Alternative Terminology

The charter is often

referred to as the articles

of incorporation.

Alternative Terminology

The charter is often

referred to as the articles

of incorporation.

1 Vote in election of board of

directors and on actions that require stockholder approval

Stockholders Rights

2 Share the corporate earnings

through receipt of dividends

The Corporate Form of Organization

Illustration 11-3

Ownership rights of stockholders

3 Keep the same percentage ownership when new shares

of stock are issued (preemptive right)

Stockholders Rights

The Corporate Form of Organization

* A number of companies have eliminated the preemptive right.

Illustration 11-3

Ownership rights of stockholders

4 Share in assets upon liquidation in proportion to their

holdings This is called a residual claim.

Stockholders Rights

The Corporate Form of Organization

Illustration 11-3

Ownership rights of stockholders

When a corporation decides to issue stock, it must resolve a

number of basic questions:

1.How many shares should it authorize for sale?

2.How should it issue the stock?

3.What value should the corporation assign to the stock?

Stock Issue Considerations

The Corporate Form of Organization

 Charter indicates the amount of stock that a corporation

is authorized to sell.

 Number of authorized shares is often reported in the

stockholders’ equity section

Authorized Stock

Stock Issue Considerations

 Companies issue common stock directly to investors or

indirectly through an investment banking firm.

 Factors in setting price for a new issue of stock:

1 Company’s anticipated future earnings.

2 Expected dividend rate per share.

3 Current financial position.

4 Current state of the economy.

Issuance of Stock

Stock Issue Considerations

 Stock of publicly held companies is traded on organized

exchanges

 Interaction between buyers and sellers determines the

prices per share

 Prices tend to follow the trend of a company’s earnings

and dividends

day-to-day fluctuations in market prices

Market Price of Stock

Stock Issue Considerations

 Years ago, par value determined the legal capital per

share that a company must retain in the business for the protection of corporate creditors

 Today many states do not require a par value

 No-par value stock is fairly common today

 In many states, the board of directors assigns a stated

value to no-par shares

Par and No-Par Value Stock

Stock Issue Considerations

Which of these statements is false?

a Ownership of common stock gives the owner a voting

right

b The stockholders’ equity section begins with paid-in

capital

c The authorization of capital stock does not result in a

formal accounting entry

d Legal capital is intended to protect stockholders

Stock Issue Considerations

Indicate whether each of the following statements is true or false.

1 Similar to partners in a partnership, stockholders of a

corporation have unlimited liability.

2 It is relatively easy for a corporation to obtain capital

through the issuance of stock.

3 The separation of ownership and management is an

advantage of the corporate form of business.

4 The journal entry to record the authorization of capital stock

includes a credit to the appropriate capital stock account.

5 All states require a par value per share for capital stock.

Paid-in Capital in Excess of Par

Paid-in capital is the total amount of cash and other assets paid in

to the corporation by stockholders in exchange for capital stock.

Corporate Capital

Paid-in Capital in Excess of Par

Account

If Delta Robotics has a balance of $800,000 in common stock

and $130,000 in retained earnings at the end of its first year,

its stockholders’ equity section is as follows

Corporate Capital

Illustration 11-5

Stockholders’ equity section

Comparison of the owners’ equity (stockholders’ equity)

accounts reported on a balance sheet for a proprietorship and

a corporation

Corporate Capital

Illustration 11-6

Comparison of owners’ equity accounts

Learning Objectives

After studying this chapter, you should be able to:

[1] Identify the major characteristics of a corporation.

[2] Record the issuance of common stock.

[3] Explain the accounting for treasury stock.

[4] Differentiate preferred stock from common stock.

[5] Prepare the entries for cash dividends and stock dividends.

[6] Identify the items reported in a retained earnings statement.

[7] Prepare and analyze a comprehensive stockholders’ equity section.

11 Corporations: Organization, Stock Transactions, Dividends,

and Retained Earnings

Accounting for Stock Transactions

Primary Objectives:

1) Identify the specific sources of paid-in capital

2) Maintain the distinction between paid-in capital and

retained earnings

Other than consideration received, the issuance of common stock

affects only paid-in capital accounts.

Accounting for Common Stock

Common Stock (1,000 x $1)

1,000

Common Stock (1,000 x $1) 1,000

Issuing Par Value Common Stock for Cash

Accounting for Common Stock

Illustration: Assume that Hydro-Slide, Inc issues 1,000

shares of $1 par value common stock Prepare

Hydro-Slide’s journal entry if (a) 1,000 share are issued for $1 per

share, and (b) 1,000 shares are issued for $5 per share.

a.

Illustration 11-7Accounting for Common Stock

Illustration: Assume that instead of $1 par value stock,

Hydro-Slide, Inc has $5 stated value no-par stock and the company

issues 5,000 shares at $8 per share for cash.

Common Stock 25,000

Paid-in Capital in Excess of Stated Value 15,000

Issuing No-Par Common Stock for Cash

Accounting for Common Stock

Illustration: What happens when no-par stock does not have a

stated value?

Common Stock

40,000

Issuing No-Par Common Stock for Cash

Accounting for Common Stock

Corporations also may issue stock for:

 Services (attorneys or consultants)

 Noncash assets (land, buildings, and equipment)

Cost is either the fair market value of the consideration given

up, or the fair market value of the consideration received,

whichever is more clearly determinable

Accounting for Common Stock

Issuing Common Stock for Services or

Noncash Assets

Illustration: Attorneys have helped Jordan Company incorporate They have billed the company $5,000 for their services They agree

to accept 4,000 shares of $1 par value common stock in payment of their bill At the time of the exchange, there is no established

market price for the stock Prepare the journal entry for this

transaction.

Common Stock (4,000 x $1)

4,000 Paid-in Capital in Excess of Par

Accounting for Common Stock

Illustration: Athletic Research Inc is an existing publicly held

corporation Its $5 par value stock is actively traded at $8 per

share The company issues 10,000 shares of stock to acquire land recently advertised for sale at $90,000 Prepare the journal entry

for this transaction.

Accounting for Common Stock

Common Stock (10,000 x $5)

50,000 Paid-in Capital in Excess of Par

30,000

THE MISSING CONTROL

Independent internal verification The company’s board of directors should have

ensured that the awards were properly administered For example, the date on the

minutes from the board meeting could be compared to the dates that were recorded

Total take: $1.7 million

ANATOMY OF A FRAUD

The president, chief operating officer, and chief financial officer of SafeNet, a software

encryption company, were each awarded employee stock options by the company’s board of

directors as part of their compensation package Stock options enable an employee to buy a

company’s stock sometime in the future at the price that existed when the stock option was

awarded For example, suppose that you received stock options today, when the stock price of your company was $30 Three years later, if the stock price rose to $100, you could “exercise” your options and buy the stock for $30 per share, thereby making $70 per share After being

awarded their stock options, the three employees changed the award dates in the company’s

records to dates in the past, when the company’s stock was trading at historical lows For

example, using the previous example, they would choose a past date when the stock was

selling for $10 per share, rather than the $30 price on the actual award date In our example,

this would increase the profit from exercising the options to $90 per share.

Learning Objectives

After studying this chapter, you should be able to:

[1] Identify the major characteristics of a corporation.

[2] Record the issuance of common stock.

[3] Explain the accounting for treasury stock.

[4] Differentiate preferred stock from common stock.

[5] Prepare the entries for cash dividends and stock dividends.

[6] Identify the items reported in a retained earnings statement.

[7] Prepare and analyze a comprehensive stockholders’ equity section.

11 Corporations: Organization, Stock Transactions, Dividends,

and Retained Earnings

Paid-in Capital in Excess of Par

Treasury stock is a corporation’s own stock that it has

reacquired from shareholders but not retired

Corporations acquire treasury stock for various reasons:

1 To reissue the shares to officers and employees under

bonus and stock compensation plans.

2 To enhance the stock’s market value

3 To have additional shares available for use in the

acquisition of other companies.

4 To increase earnings per share

Accounting for Treasury Stock

Purchase of Treasury Stock

 Debit Treasury Stock for the price paid to

reacquire the shares.

account Reduces stockholders’ equity.

Accounting for Treasury Stock

Both the number of shares issued (100,000) and the number of shares held

as treasury (4,000) are disclosed.

Accounting for Treasury Stock

Illustration 11-9

Stockholders’ equity with treasury stock

Sale of Treasury Stock

Both increase total assets and stockholders’ equity

Accounting for Treasury Stock

Disposal of Treasury Stock

Illustration: On July 1, Mead sells for $10 per share 1,000

shares of its treasury stock previously acquired at $8 per share and makes the following entry

Treasury Stock 8,000

Paid-in Capital from Treasury Stock 2,000

A corporation does not realize a gain or suffer a loss from

stock transactions with its own stockholders

Sale of Treasury Stock “Above” Cost

Illustration: On Oct 1, Mead sells an additional 800 shares of treasury stock at $7 per share and makes the following entry.

Illustration 11-10

Treasury stock accounts

Sale of Treasury Stock “Below” Cost

Paid-in Capital from Treasury Stock 800

Treasury Stock 6,400

Cash 15,400 Paid-in Capital from Treasury Stock 1,200

Treasury Stock 17,600

Illustration: On Dec 1, assume that Mead, Inc sells its

remaining 2,200 shares at $7 per share and makes the following entry

Sale of Treasury Stock “Below” Cost

Limited to balance

on hand

Learning Objectives

After studying this chapter, you should be able to:

[1] Identify the major characteristics of a corporation.

[2] Record the issuance of common stock.

[3] Explain the accounting for treasury stock.

[4] Differentiate preferred stock from common stock.

[5] Prepare the entries for cash dividends and stock dividends.

[6] Identify the items reported in a retained earnings statement.

[7] Prepare and analyze a comprehensive stockholders’ equity section.

11 Corporations: Organization, Stock Transactions, Dividends,

and Retained Earnings

Typically, preferred stockholders have a priority as to:

1 Distributions of earnings (dividends).

2 Assets in event of liquidation.

Generally do not have voting rights.

Accounting for preferred stock at issuance is similar to that for

common stock

Accounting for Stock Transactions

Accounting for Preferred Stock