978-1133939283 Chapter 13 Lecture Note Part 1

subject Type Homework Help
subject Pages 7
subject Words 2145
subject Authors Belverd E. Needles, Marian Powers

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Chapter 13
Accounting for Corporations
Learning Objectives
1. Dene the corporate form of business and its characteristics.
2. Identify the components of stockholders’ equity and their characteristics.
3. Account for the issuance of stock for cash and other assets.
4. Account for treasury stock.
5. Account for cash dividends.
6. Account for stock dividends and stock splits.
7. Describe the statement of stockholders’ equity and compute book value per share.
8. Calculate dividend yield and return on equity, and dene stock options.
Section 1: Concepts
Concept
Separate entity
Lecture Outline
I. The corporate form of business is well suited to today’s trends toward large
organizations, international trade, and professional management.
A. Contributed capital refers to stockholders’ investments in a corporation.
B. The articles of incorporation form the company charter and become a contract
between the state and the incorporators.
C. Stockholders purchase a unit of ownership called a share of stock.
D. The board of directors decides major business policies and has specic duties,
including:
1. Authorizing contracts.
2. Setting executive compensation.
3. Arranging major loans with banks.
4. Declaration of dividends.
E. Management is appointed by board of directors to manage the business and
report nancial results.
II. Managers must be familiar with the advantages and disadvantages of incorporation.
A. Advantages of Incorporation include:
1. Separate legal entity
2. Limited liability
3. Ease of capital generation
4. Ease of transfer of ownership
5. Lack of mutual agency
6. Continuous existence
7. Centralized authority
8. Professional management
B. Disadvantages of Incorporation include:
1. Government regulation.
2. Double taxation.
3. Limited liability.
4. Separation of ownership and control.
III. Equity Financing is accomplished by issuing stock to investors.
A. Large corporations can have millions of shares and often appoint registrars
and transfer agents to handle transfer duties.
B. Par value is the arbitrary amount assigned to each share of stock.
C. Legal capital is the number of shares multiplied by the par value.
D. An underwriter helps with the initial public o6ering (IPO)
E. Start-up and organization costs include:
1. State incorporation fees.
2. Attorneys’ fees for drawing up the articles of incorporation.
3. The cost of printing stock certicates.
4. Accountants’ fees for registering the rm’s initial stock.
B. Advantages of equity nancing include:
1. Decreased nancial risk.
2. Increased cash for operations.
3. Better debt to equity ratio.
C. Disadvantages of equity nancing include:
1. Increased tax liability.
2. Decreased shareholder control.
Summary
Corporation was dened in Chapter 1 as a separate entity chartered by the state and legally
separate from its owners—stockholders. Contributed capital refers to stockholders’
investments in a corporation. Articles of incorporation are led with the state and form
the company charter and become a contract between the state and the incorporators. A unit
of ownership in a corporation is called a share of stock. The articles of incorporation state
the maximum number of shares that a corporation is authorized to issue. The stockholders
elect a board of directors, which decides on major business policies including setting
executive compensation, arranging major loans, and declaring dividends. Dividends are
distributions to stockholders of the earnings of the corporation. Members of the board of
directors generally include independent directors in addition to o<cers of the corporation
and major shareholders.
Management is appointed by the board of directors to carry out corporate policies and run
day-to-day operations. Management consists of the operating o<cers—generally the
president, or CEO; vice presidents; chief nancial o<cer; and chief operating o<cer.
Management is also responsible for reporting nancial results to the board of directors and
stockholders.
Advantages of incorporation include:
Separate legal entity
Limited liability
Ease of capital generation
Ease of transfer of ownership
Lack of mutual agency
Continuous existence
Centralized authority and responsibility
Professional management
Disadvantages of incorporation include:
Government regulation
Double taxation
Limited liability in that it restricts the ability of a small corporation to borrow money
Separation of ownership and control
Equity #nancing is accomplished by issuing stock to investors in exchange for assets,
usually cash. Large corporations may have millions of shares of stock and often appoint
independent registrars and transfer agents (usually banks and trust companies) to help
perform the transfer duties, including transferring the corporation’s stock, maintaining
stockholders’ records, preparing a list of stockholders for stockholders’ meetings, and paying
dividends.
Par value is an arbitrary amount assigned to each share of stock and must be recorded in
the capital stock accounts. Par value does not represent the market value of the stock. Par
value is the legal capital, which is the number of shares issued multiplied by the par value.
Legal capital is the minimum amount the corporation can report as contributed capital.
To issue new shares of stock, a corporation often uses an underwriter—an intermediary
between the corporation and the investing public. The underwriter charges a fee to issue the
stock with the net proceeds going to the corporation, which records it in the Capital Stock
and Additional Paid-in Capital accounts.
Start-up and organization costs include:
State incorporation fees
Attorneys’ fees for drawing up the articles of incorporation
Cost of printing stock certicates
Accountants’ fees for registering the rm’s initial stock
Other expenses necessary for the formation of the corporation
Advantages of equity nancing include:
Decreased nancial risk – less debt nancing lowers nancial risk
Increased cash for operations when the corporation does not pay a dividend or has
minimal interest costs from debt nancing
Better debt to equity ratio
Disadvantages of equity nancing include:
Increased tax liability – if the corporation was to use debt nancing, interest expense
is tax deductible whereas dividends are not tax deductible
Decreased stockholder control – as more stock is issued to new shareholders, the
current stockholders’ control is diluted
Relevant Examples and Exhibits
Exhibit 1 The Corporate Organization
Teaching Strategy
Write “Advantages” and “Disadvantages” (of the corporate form of business) on the board,
and ask students to give examples of each. Be sure students say why an item is an
advantage or a disadvantage. Note that limited liability is both an advantage and a
disadvantage.
Explain what costs are included in the start-up and organization costs.
Discuss equity nancing and compare it to debt nancing. Ask students how equity nancing
impacts the balance sheet, the income statement, cash Cows, and shareholder ownership.
Short Exercises 1 and 2 and Exercise 1A apply this section.
Section 2: Accounting Applications
Accounting Applications
Prepare the statement of stockholders’ equity
Record the issuance of stock for cash and other assets
Record the purchase, sale, and retirement of treasury stock
Account for cash dividends
Accounting for dividends and stock splits
Lecture Outline
I. The components of stockholders’ equity include contributed capital, retained earnings,
and treasury stock.
A. Contributed capital represents stockholders’ investments in the corporation.
1. A corporation can issue two types of stock:
a. Common stock
b. Preferred stock
2. For each type of stock:
a. Authorized shares are the maximum a corporation can issue.
b. Issued shares have been sold/transferred to stockholders.
c. Outstanding shares are the issued shares still in circulation.
B. Retained earnings represent income reinvested in the business.
C. Treasury stock are shares the corporation has bought back.
D. Corporations may summarize details of changes in each component in a separate
statement of stockholders’ equity.
II. Preferred stock has one or more of the following characteristics over common stock:
A. Preference as to dividends:
1. Noncumulative preferred stock – no make up of missed dividends.
2. Cumulative preferred stock – the dividend amount per share accumulates
from year to year.
a. Dividends in arrears are dividends not paid in the year due.
b. Dividends are distributed in following order: dividends in arrears,
preferred dividends, common dividends.
B. Preference as to assets upon liquidation:
1. Preferred stockholders receive par value or larger stated liquidation value.
2. Preference also extends to dividends in arrears.
C. Convertible feature
1. Owners of convertible preferred stock can exchange their shares for preferred
stock.
D. Callable feature
1. Issuing corporation can redeem the stock at will.
2. When called and surrendered, the stockholder is entitled to:
a. the par value of the stock.
b. the call premium.
c. dividends in arrears.
d. current dividends prorated to call date.
III. Common stock may be either par or no-par.
A. Par value is stated in corporate charter.
1. Par value does not represent market value.
2. Total of par values must be maintained as legal capital.
B. A corporation may issue no-par stock to:
1. Avoid confusion with market value.
2. Increase Cexibility.
IV. When accounting for stock issued above par value, the excess is credited to Additional
Paid-in Capital.
V. When accounting for no-par stock issued:
A. All proceeds are credited to Common Stock if there is no stated value.
B. Any excess above a stated value is credited to Additional Paid-in Capital.
VI. When accounting for stock issued in exchange for noncash assets:
A. If no market value for stock exists, the transaction is recorded at the market
value of the noncash assets.
B. If a market value for the stock exists, the transaction is recorded based on
market value of the stock.
VII. Treasury stock is issued stock the corporation has bought back.
A. Treasury stock may be purchased for the following reasons:
1. To use for employee stock option plans.
2. To maintain a favorable market for the company’s stock.
3. To increase earnings per share.
4. To use to purchase other companies.
5. To prevent a hostile takeover of the company.
B. When accounting for a treasure stock purchase:
1. Treasury Stock is debited for the full purchase price, not par value.
2. Treasury stock appears as a deduction in the stockholders’ equity
section of the balance sheet.
C. When accounting for a sale of treasury stock:
1. Treasury Stock is credited for its original cost.
2. Paid-in Capital, Treasury Stock is credited for any amount above cost.
3. If treasury stock is sold below cost:
a. Paid-in Capital, Treasury Stock is debited for the amount below cost to
the point its credit balance is depleted.
b. If Paid-in Capital, Treasury Stock has an insu<cient credit balance,
Retained Earnings is debited for the di6erence.
D. When accounting for the retirement of treasury stock:
1. Debit common stock for par value.
2. Debit Additional Paid-in Capital to remove any amount recorded at original
stock issue above par.
3. Debit Retained Earnings for di6erence between original issue price and
buy-back price.
4. Credit Treasury Stock for purchase price.
VIII. Cash dividends are declared by the board of directors.
A. Dividends are paid from retained earnings.
1. Liquidating dividends (from contributed capital) are only paid if a company is
going out of business or reducing operations.
B. When accounting for dividend transactions:
1. Record a liability on the declaration date.
2. Make no entry on the record date.
a. On record date, ownership of stock for dividend is determined.
b. Stock sells ex-dividend between declaration and record dates.
3. Record payment of liability on payment date.
IX. A stock dividend is a proportional distribution of additional shares to stockholders.
A. A stock dividend involves no distribution of assets and has no e6ect on assets
and liabilities on the balance sheet.
B. A stock dividend may be declared for the following reasons:
1. To give stockholders some evidence of success without a6ecting working
capital.
2. To reduce the stock’s market price (albeit more often done with stock
split).
3. To make a nontaxable distribution to stockholders.
4. To increase the company’s permanent capital.
C. When accounting for stock dividend transactions:
1. Record the obligation on the declaration date by crediting Common Stock
Distributable (an equity account).
2. Make no entry on the record date.
3. Record the distribution on the payment date by debiting Common Stock
Distributable and crediting Common Stock.
D. The e6ects of a stock dividend on stockholders’ equity include the following:
1. Contributed capital will increase while retained earnings will decrease (Stock
Dividends is eventually closed to Retained Earnings), but the net amount of
equity will stay the same.
2. The proportionate ownership of each stockholder also stays the same.
E. Large stock dividends tend to e6ect market price downward.
X. A stock split increases the number of shares while reducing par or stated value
proportionately.
A. Stock splits are usually issued to lower market price per share and to signal
success in achieving operating goals, thus driving up demand.
B. When accounting for stock splits, only a memorandum entry is recorded since
all equity account balances remain the same.
XI. A statement of stockholders’ equity is prepared to summarize the changes in the equity
accounts over the period.
XII. Book value per share represents the stockholder’s ownership interest in the company.
A. If only common stock, it is calculated as total equity divided by total shares
outstanding.
B. If both common and preferred stock:
1. The preferred stock’s call or par value and any dividends in arrears are totaled
and then divided by total preferred shares outstanding to obtain book value
per preferred share.
2. The total determined in (1) is deducted from total equity before dividing by
total common shares outstanding to obtain book value per common share.
XIII. On the balance sheet, the stockholders’ equity of a corporation is separated into
contributed capital, retained earnings, and treasury stock as shown in text Exhibit 6.

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