CHAPTER 13
CORPORATIONS: ORGANIZATION AND
CAPITAL STOCK TRANSACTIONS
LEARNING OBJECTIVES
1. DISCUSS THE MAJOR CHARACTERISTICS OF A
CORPORATION.
CHAPTER REVIEW
The Corporate Form of Organization
1. (L.O. 1) A corporation is an entity created by law that is separate and distinct from its owners
and its continued existence is dependent upon the corporate statutes of the state in which it is
incorporated.
2. The characteristics that distinguish a corporation from proprietorships and partnerships are:
a. The corporation has separate legal existence from its owners.
b. The stockholders have limited liability.
Forming a Corporation
3. A corporation is formed by grant of a state charter. Upon receipt of its charter from the state of
incorporation the corporation establishes by-laws which are the internal rules and procedures for
conducting the affairs of the corporation.
Stockholder Rights
4. When chartered, the corporation may begin selling ownership rights in the form of shares of stock.
Each share of common stock gives the stockholder the following ownership rights:
a. To vote for the board of directors and in corporate actions that require stockholder approval.
Stock Issue Considerations
5. Authorized stock is the amount of stock a corporation is allowed to sell as indicated by its charter.
a. The authorization of capital stock does not result in a formal accounting entry.
b. The difference between the shares of stock authorized and the shares issued is the number
8. No-par stock is capital stock that has not been assigned a value in the corporate charter. In
many states the board of directors can assign a stated value to the shares which becomes the
legal capital per share. When there is no assigned stated value, the entire proceeds are consid-
ered to be legal capital.
Corporate Capital
9. Owner’s equity in a corporation is identified as stockholders’ equity, shareholders’ equity, or
corporate capital. The stockholders’ equity section of a corporation’s balance sheet consists of:
(a) paid-in (contributed) capital, and (b) retained earnings (earned capital).
10. Paid-in capital is the total amount of cash and other assets paid into the corporation by
stockholders in exchange for capital stock.
13. When par value common stock is issued for cash, the par value of the shares is credited to Common
Stock and the portion of the proceeds that is above or below par value is recorded in a separate
paid-in capital account.
Issuing Common Stock for Services or NonCash Assets
15. When common stock is issued for services or noncash assets, cost is either the fair value of the
consideration given up or the consideration received, whichever is more clearly determinable.
Treasury Stock
16. (L.O. 3) Treasury stock is a corporation’s own stock that has been issued and subsequently
reacquired from shareholders but not retired.
a. Under the cost method, Treasury Stock is debited at the price paid for the shares and the
Preferred Stock
17. Preferred stock has contractual claims that give it some preference or priority over common stock.
Preferred stockholders usually have a priority to distributions of earnings (dividends) and assets in the
event of liquidation. However, they usually do not have voting rights.
18. When a corporation has more than one class of stock, each paid-in capital account title should
identify the stock to which it relates (e.g., Preferred Stock, Paid-in Capital in Excess of Par—
Preferred Stock). Preferred stock is shown first in the stockholders’ equity section.
Cumulative Dividend
19. A cumulative dividend provides that preferred stockholders must be paid both current and prior–
year dividends before common stockholders receive any dividends.
Statement Presentation
20. (L.O. 4) In the stockholders’ equity section, paid-in capital and retained earnings are reported
and the specific sources of paid-in capital are identified. Within paid-in capital, two classifications
are recognized.
a. Capital stock, which consists of preferred and common stock. Preferred stock appears
LECTURE OUTLINE
A. The Corporate Form of Organization.
1. The prevailing legal interpretation of a corporation is an entity separate
and distinct from its owners.
2. A corporation may be organized for the purpose of making a profit, or it
may be not-for-profit.
3. Classification by ownership differentiates publicly held and privately held
corporations.
a. A publicly held corporation may have thousands of stockholders,
and its stock is regularly traded on a national securities exchange.
B. Characteristics of a Corporation.
1. Separate legal existence. As an entity separate and distinct from its
owners, the corporation acts under its own name rather than in the name
of its stockholders.
5. Continuous life. The life of a corporation is stated in its charter. It may be
perpetual, or it may be limited to a specific number of years.
6. Corporation management. Stockholders legally own the corporation,
but they manage the corporation indirectly through a board of directors they
elect. The board, in turn, formulates operating policies and also selects
officers to execute policy and to perform daily management functions.
C. Forming a Corporation.
1. A corporation is formed by grant of a state charter that describes the
name and purpose of the corporation, the types and number of shares of
stock that are authorized to be issued, and the names of the individuals
that formed the company.
2. It is to a company’s advantage to incorporate in a state whose laws are
favorable to the corporate form of business organization.
D. Stockholder Rights.
1. Each share of common stock gives the stockholder the following ownership
rights:
a. Each share of stock entitles the owner to vote in the election of the
board of directors and in corporate actions that require stockholder
approval.
b. Stockholders share in corporate earnings through the receipt of
dividends.
E. Stock Issue Considerations.
1. Authorized stock. The charter indicates the amount of stock that a corpo–
ration is authorized to sell.
2. Issuance of stock. A corporation can issue common stock directly to
investors. Alternatively, it can issue the stock indirectly through an
4. Par and no-par value stocks. Par value stock is capital stock to which
the charter has assigned a value per share. No-par value stock is capital
INVESTOR INSIGHT
Shares in excess of a billion are often traded daily on the New York Stock
Exchange. For each listed stock, the Wall Street Journal reports the total volume
of stock traded for a given day, the high and low price for the day, the closing
market price, and the net change for the day.
How are the dollar prices per share established for stocks traded on organized
stock exchanges? What factors might influence the price of shares in the market–
place?
Answer: The dollar prices per share are established by the interaction between
buyers and sellers of the shares.
F. Corporate Capital.
1. Owners’ equity in a corporation is identified as stockholders’ equity,
shareholders’ equity, or corporate capital.
2. The stockholders’ equity section of a corporation’s balance sheet consists of:
a. Paid-in (contributed) capital. Paid-in capital is the total amount of
cash and other assets paid in to the corporation by stockholders in
G. Accounting for Issues of Common Stock.
1. The primary objectives in accounting for the issuance of common stock
are to:
a. Identify the specific sources of paid-in capital.
b. Maintain the distinction between paid-in capital and retained earnings.
2. When the company records issuance of common stock for cash, it credits
the par value of the shares to Common Stock. It also records in a
separate paid-in capital account the portion of the proceeds that is
above or below par value.
H. Accounting for Treasury Stock.
1. Treasury stock is a corporation’s own stock that it has issued and
subsequently reacquired from shareholders but not retired.
2. Companies generally account for treasury stock by the cost method.
Under this method, companies debit Treasury Stock for the price paid to
reacquire the shares, and when they dispose of the shares, they credit
Treasury Stock for the same amount paid to reacquire the shares.
ACCOUNTING ACROSS THE ORGANIZATION
Reebok at one time bought back nearly a third of its shares which dramatically
reduced its available cash. Critics suggested that Reebok’s management was
repurchasing shares to make it less likely that another company would acquire
Reebok.
What signal might a large stock repurchase send to investors regarding man-
agement’s belief about the company’s growth opportunities?
I. Accounting for Preferred Stock.
2. Preferred stock has contractual provisions that give it some preference
or priority over common stock. Typically, preferred stockholders have a
priority as to:
a. Distributions of earnings (dividends).
b. Assets in the event of liquidation.
3. Preferred stock dividend preferences may be classified as:
a. Cumulative—preferred stockholders must be paid both current-year
dividends and any unpaid prior-year dividends before common
b. Participating – preferred stock may have the right to receive
J. Statement Presentation and Analysis.
Within paid-in capital, companies use the following classifications:
1. Capital stock. This category consists of preferred and common stock.
Preferred stock appears before common stock because of its preferential
2. Additional paid-in capital. This category includes the excess of amounts
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. The cost method derives its name from the fact that the Treasury Stock account is maintained
at the cost of shares purchased.
True False
2. When treasury stock is sold for an amount greater than its cost, the difference should be
credited to Gain on Sale of Treasury Stock and reported as other income on the income
statement.
True False
3. Stockholders’ liability is generally unlimited; therefore, creditors have recourse to stockholders’
personal assets as well as corporate assets.
True False
4. Retained earnings is net income retained in a corporation and is often referred to as
earned capital.
True False
5. A corporation is bound to a contract entered into by one of its stockholders.
True False
6. Issued shares of stock less outstanding shares equals treasury stock.
True False
7. The cumulative feature of stock applies to preferred stock.
True False
8. Dividends in arrears are not considered a liability because no obligation exists until the
dividend is declared by the board of directors.
True False
9. Preferred stockholders have a priority as to dividends but not to assets in the event of
liquidation.
True False
10. Treasury stock should be listed as an asset in the balance sheet.
True False
Multiple Choice
1. Par value
a. represents what a share of stock is worth.
b. represents the original selling price for a share of stock.
c. is the legal capital established for a share of stock.
d. is established for a share of stock after it is issued.
2. If a company has 900,000 shares of common stock authorized, and has 750,000 shares
issued, and holds 30,000 shares of common stock as treasury stock, the general ledger
account for common stock, $1 par value would have a balance of
a. $870,000.
b. $750,000.
c. $720,000.
d. $150,000.
3. All of the following balances are normally found in a corporation’s stockholders’ equity
section except
a. common stock.
b. paid-in capital in excess of par.
c. retained earnings.
d. dividends in arrears.
4. Preferred stock would least likely have which characteristic?
a. The right of the holder to vote at stockholders’ meetings.
b. The right of the corporation to redeem or retire the stock.
c. Preference as to assets upon liquidation of the corporation.
d. Preference as to dividends.
5. A company purchases 1,500 shares of its $25 par value stock at $35 per share. It then
reissues 500 shares at $40 per share. The entry upon reissue of the stock would include
a credit to
a. Cash for $2,500.
b. Treasury Stock for $2,500.
c. Retained Earnings for $2,500.
d. Paid-in Capital from Treasury Stock for $2,500.
ANSWERS TO QUIZ
True/False
1. True 6. True
2. False 7. True
Multiple Choice
1. c.