Chapter (13)

Corporations : Organization and Capital Stock Transactions

The Corporate Form of Organization:

• Corporation
* Entity created by law.
* Separate and distinct from its owners.
• Two common bases for classification of corporations are:
1) By purpose.
 To earn profit, or
 Nonprofit.
2) By ownership.
 Publicly-held corporations.
* May have thousands of stockholders
* Stock is regularly traded on a national securities
exchange.
 Privately-held corporations.
* Often referred to as closely held corporations,
usually have only a few stockholders.
* Does not offer its stock for sale to the general public.

Characteristics of a Corporation:
• Separate legal existence from its owners.
• Stockholders have limited liability.
• Ownership held in shares of capital stock (transferable
units).
• Ability to acquire capital through the issuance of stock.
• Continuous life.
• Corporate management
– is at the discretion of the board of directors who are
elected by the stockholders
• Subject to numerous government regulations.
• Must pay an income tax on its earnings
• Stockholders are required to pay taxes on the dividends
they receive: the result is double taxation.

Advantages and Disadvantages of a Corporation:

Advantages:
1. Separate legal existence.
2. Limited liability of stockholders.

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 3. Transferable ownership rights
4. Ability to acquire capital.
5. Continuous life.
6. Corporation management – professional managers.

Disadvantages:
1. Corporation management – separation of ownership and
management.
2. Government regulations.
3. Additional taxes.

Organization Costs:
• Costs incurred in forming a corporation include legal fees, state
fees and promotional expenditures.
• Organization costs are expensed as incurred since it is so difficult
to determine the amount and timing of future benefits.

Ownership Rights of Stockholders:

1) Vote in election of board of directors and inactions that require
stockholders approval.
2) Share in corporate earnings through the receipt of dividends.
3) Preemptive right which means maintain the same percentage
ownership when additional shares of common stock are issued.
4) Residual claim Share in assets upon liquidation.

Stock Issue Considerations:

In considering the issuance of stock, a number of basic questions
must be resolved:
 How many shares should be authorized for sale?
 How should the stock be issued?
 At what price should the stock be issued?
 What value should be assigned to the stock?

These questions are answered below:

Authorized stock:
* Amount of stock a corporation is allowed to sell as
indicated by its charter.
* The authorization of capital stock does not result in a
formal accounting entry. This event has no immediate
effect on either corporate assets or stockholders’
equity.

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Issuance of Stock:
* A corporation can issue common stock directly to investors or
indirectly through an investment banking firm (brokerage
house).
– Direct issue is typical in closely held companies.
– Indirect issue is customary for a publicly held corporation.
* In an indirect issue, the investment banking firm may agree to
underwrite the entire stock issue. In this arrangement, the
investment banker buys the stock from the corporation at a
stipulated price and resells the shares to investors.

Market Value of Stock:

• Publicly held companies:
– traded on organized exchanges.
– dollar prices per share are established by the interaction
between buyers and sellers
• The prices set by the marketplace generally follow the trend of a
company’s earnings and dividends.

Par Value & No-Par Value Stock:

• Par value stock:
– Capital stock that has been assigned a value per share in the
corporate charter,
– Represents the legal capital per share that must be retained
in the business for the protection of corporate creditors (i.e.,
not available for withdrawal by stockholders).
• No-par stock
– 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 then becomes the legal capital per share. When there is
no assigned stated value, the entire proceeds are considered to be legal
capital.
Corporate Capital:
• Owner’s equity in a corporation is identified as stockholders’
equity, shareholders’ equity, or corporate capital.
• Stockholders’ equity section of a corporation’s balance sheet
consists of:
1. Paid-in (contributed) capital:
Total amount of cash and other assets paid in to
the corporation by stockholders in exchange
for capital stock.

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 2. Retained earnings (earned capital):
Net income that is retained in a corporation.

Net income is recorded in Retained Earnings by a closing entry in

which Income Summary is debited and Retained Earnings is credited.
For example, if net income for Delta Robotics is $130,000 in its first year
of operations, the closing entry is:

Date Account Title and Explanation Dr. Cr.

Income Summary 130000
Retained Earnings 130000
(to close income summary and transfer
net income to retained earnings).

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

the end of its first year, its stockholders’ equity section is as follows:

Delta Robotics
Balance Sheet (partial)

Stockholders’ Equity:
Paid-in-capital
Common stock $800000
Retained Earnings 130000
Total stockholders’ Equity $930000

Accounting for Common Stock Issues:

* The primary objectives in accounting for the issuance of common stock are:
(1) To identify the specific sources of paid-in capital.
(2) To maintain the distinction between paid-in capital and retained
earnings.
* The issuance of common stock affects only paid-in capital accounts.

Issuing Par Value Common Stock for Cash:

 The par value does not indicate the market value of the
stock. Therefore, the cash proceeds from issuing par value
common stock may be equal to, greater than, or less than par value.

 When the issuance of common stock for cash is recorded,

and the par value of the shares is NOT the same as the cash price, the
par value is credited to Common Stock, and the portion of the

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 proceeds that is above or below par value is recorded in a separate
paid-in-capital account.

Example:
Assume that Hydro-Slide, Inc. issues 1,000 shares of $1 par value common
stock at par for cash, the entry to record this transaction is:

Date Account Title and Explanation Dr. Cr.

Cash 1000
Common Stock 1000
To record issuance of 1000 shares of $1
Par value common stock at par.

If Hydro-Slide issues an additional 1000 shares of the $1 par value common

stock for cash at $5 per share, the entry is:

Date Account Title and Explanation Dr. Cr.

Cash (1000 shares × $5) 5000
Common Stock (1000 shares × $1) 1000
Paid-in capital in Excess of Par Value 4000
(1000 shares × $4)
To record issuance of 1000 shares of $1
par value common stock for $5 per share.

Stockholders’ Equity: Paid-in Capital in Excess of Par Value Balance Sheet

Presentation:
The total paid-in-capital from these transactions is $6,000, and the legal
capital is $2,000. If Hydro-Slide, Inc. has retained earnings of $27,000, the
stockholders’ equity section is as follows:

Hydro-Slide. Inc.
Balance Sheet (Partial)

Stockholders’ Equity:
* Paid-in capital
Common Stock $2000
Paid-in capital in excess of par value 4000
Total paid-in capital 6000
* Retained Earnings 27000
Total stockholders’ Equity $33000

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  When stock is issued for less than par value, the account
Paid-in capital in Excess of Par Value is debited, if a credit balance
exists in that account. If a credit balance does not exist, then the
amount less than par value is debited to Retained Earnings.
However, this situation is very rare.

Issuing No-Par Common Stock for Cash:

When no-par common stock has a stated value, the stated value is
credited to Common Stock. When the selling price exceeds the stated value,
the excess is credited to Paid-in Capital in Excess of Stated Value.

Example:
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. The entry is:

Date Account Title and Explanation Dr. Cr.

Cash (5000 shares × $8) 40000
Common Stock (5000 shares × $5 stated value) 25000
Paid-in capital in Excess of Stated Value 15000
(5000 shares × $3)
To record issuance of 5000 shares of $5 stated
value no-par stock for $8 per share.

 Paid-in Capital in Excess of Stated Value is reported as

part of paid-in capital in the stockholders’ equity section.

 When no-par stock does not have a stated value, the entire
proceeds from the issue are credited to Common Stock.

Example:
If Hydro-Slide Inc. does not assign a stated value to its no-par stock, the
issuance of the 5,000 shares at $8 per share for cash is recorded as follows:

Date Account Title and Explanation Dr. Cr.

Cash (5000 shares × $8) 40000
Common Stock (5000 shares × $8) 40000
To record issuance of 5000 shares of no-par stock. f

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Issuing Common Stock for Services or Noncash Assets:
• Stock may also be issued for services (compensation to attorneys
or consultants), or for noncash assets (land, buildings, or
equipment).

• In case of common stock issued for services or non-cash assets, the

cost principle must be complied with.
– Cost is either the fair market value of the consideration
given up, or the consideration received, whichever is more
clearly determinable.

Example:
Assume that attorneys have helped Jordan Company incorporate. They
have billed the company $5000 for their services. They agree to accept 4000
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.

In this case, the market value of the consideration received (the attorney
services) $5000 is more clearly evident. Accordingly, the entry is recorded in
the following manner:

Date Account Title and Explanation Dr. Cr.

Organization Expense 5000
Common Stock (4000 shares × $1) 4000
Paid-in capital in Excess of Par Value 1000
To record issuance of 1000 shares of $1
par value common stock to attorneys.

 As explained earlier, organization costs are expensed as

incurred.

Example:
Assume that Athletic Research Inc. is a publicly held corporation. Its $5
par value 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.

The most clearly evident value is the MARKET VALUE of the

consideration given (the shares of stock), which is $80,000. This transaction
is recorded in the following manner:

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 Date Account Title and Explanation Dr. Cr.
Land (10000 shares × $8) 80000
Common Stock (10000 shares × $5 PV)
Paid-in capital in Excess of Par Value 50000
(10000 shares × $3) 30000
To record issuance of 10000 shares of $5
par value common stock for land.

NOTE: The par value of the stock is NEVER a factor in determining

the cost of the assets received. This is also true of the stated value of
the no par stock.

Accounting for Treasury Stock:

* Treasury stock is a corporation's own stock that has been issued, fully paid
for, and reacquired but not retired. A corporation may acquire treasury stock
for several reasons:
1) To reissue the shares to officers or employees.
2) To increase trading thereby enhancing market value.
3) To have additional shares available for use in acquisitions of
other companies.
4) To reduce the number of shares outstanding and thereby
increase earnings per share.
5) To rid the company of disgruntled investors, perhaps to avoid
a takeover.

Purchase of Treasury Stock:

* Treasury stock is generally accounted for by the cost method. Under the
cost method, Treasury Stock is debited for the price paid for the shares. The
same amount is credited to Treasury Stock when the shares are disposed of.

Example:
Assume that on January 1, 2005, the stockholders’ equity section of Mead,
Inc. has 100,000 shares of $5 par value common stock outstanding (all issued
at par value) and retained earnings of $200,000. The stockholders’ equity
section before purchase of treasury stock is as follows:

Mead, Inc.

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 Balance Sheet (partial)

Stockholders’ Equity
* Paid-in capital
Common stock, $5 par value, 100000 shares
issued and outstanding $500000
* Retained Earnings 200000
Total stockholders’ equity $700000

On February 1, 2005, Mead acquires 4000 shares of its stock at $8 per

share. The entry is:

Date Account Title and Explanation Dr. Cr.

Feb. 1 Treasury Stock (4000 shares × $8 cost) 32000
Cash 32000
To record purchase of 4000 shares of treasury
stock at $8 per share.

Note that Treasury Stock is debited for the cost of the shares purchased.

In the stockholders’ equity section of the balance sheet, treasury stock is

deducted from total paid-in capital and retained earnings.

Treasury Stock is a contra stockholders’ equity account.

The stockholders’ equity section of Mead, Inc. after purchase of

treasury stock is as follows:

Mead, Inc.
Balance Sheet (partial)

Stockholders’ Equity
* Paid-in capital
Common stock, $5 par value, 100000 shares
issued and 96000 shares outstanding $500000
* Retained Earnings 200000
Total paid-in capital and retained earnings $700000
Less: Treasury stock (4000 shares) 32000
Total stockholders’ equity $668000

* Thus, The acquisition of treasury stock REDUCES stockholders’

equity.

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* The term outstanding stock means the number of shares of issued stock that
are being held by stockholders.

Disposal of Treasury Stock:

* Treasury stock is usually sold or retired. The accounting for its sale is
different when treasury stock is sold above cost than when it is sold below
cost.
* Selling price of the shares is greater than cost
• The difference is credited to Paid-in Capital from
Treasury Stock.
* Selling price is less than cost
• The excess of cost over selling price is usually debited
to Paid-in Capital From Treasury Stock. When there
is no remaining credit balance in Paid-in Capital
From Treasury Stock, the remainder is debited to
Retained Earnings.

Sale of Treasury Stock Above Cost:

Example (1):
Assume that 1,000 shares of treasury stock of Mead, Inc., previously acquired
at $8 per share, are sold at $10 per share on July 1. The entry is:

Date Account Title and Explanation Dr. Cr.

July. 1 Cash (1000 shares × $10 sale price) 10000
Treasury Stock (1000 shares × $8 cost) 8000
Paid-in Capital from Treasury Stock 2000
(1000 shares × $2 above cost)
To record sale of 1000 shares of treasury stock
above cost.

Note: The $2,000 credit in the entry would not be considered

a Gain on Sale of Treasury Stock for two reasons:
1. Gains on sales occur when assets are sold, and
treasury stock is not an asset.
2. A corporation does not realize a gain or suffer a loss
from stock transactions with its own stockholders.

* Paid-in capital from treasury stock is listed separately on the balance

sheet as a part of paid-in capital.
Sale of Treasury Stock Below Cost:
Example (2):

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Assume instead that Mead, Inc. sells an additional 800 shares of treasury
stock on October 1 at $7 per share, the entry is:

Date Account Title and Explanation Dr. Cr.

Oct. 1 Cash (800 shares × $7 sale price) 5600
Paid-in Capital from Treasury Stock 800
(800 shares × $1 below cost)
Treasury Stock (800 shares × $8 cost) 6400
To record sale of 800 shares of treasury stock
below cost.

* Post the above two transactions.

Example (3):
Assume that Mead sells its remaining 2200 shares at $7 per share on
December 1.

The excess of cost over selling price = 2200 × $1 = $2200

Since the Paid-in Capital from Treasury Stock account has only a credit
balance of $1200, it is debited for that amount and the remaining $1000 is
debited to the Retained Earnings account as shown below:

Date Account Title and Explanation Dr. Cr.

Dec. 1 Cash (2200 shares × $7 sale price) 15400
Paid-in Capital from Treasury Stock 1200
Retained Earnings 1000
Treasury Stock (2200 shares × $8 cost) 17600
To record sale of 2200 shares of treasury stock
below cost.

Preferred Stock:
• Preferred stock has contractual provisions that give it a preference or
priority over common stock in certain areas:
1) Distribution of earnings.
2) Assets in the event of liquidation.
• Usually do not have voting rights.
• Shown first in the stockholders' equity section.
• Identified separately from other stock and paid-in capital
accounts.

* The entries for the issuance of preferred stock are similar to the entries
of common stock.

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Example:
Assume that Stine Corporation issues 10000 shares of $10 par value
preferred stock for $12 cash per share. The entry to record the issuance is:

Date Account Title and Explanation Dr. Cr.

Cash (10000 shares × $12Market price) 120000
Preferred Stock (10000 shares × $10) 100000
Paid-in Capital in Excess of Par Value – P.S 20000
(10000 shares × $2)
To record the issuance of 10000 shares of $10
Par value preferred stock.

Dividend Preferences:
* The per share dividend amount is stated as a percentage of the
preferred stock’s par value or as a specified amount. For example, a 4%
preferred stock $100 par value means that the dividends on the preferred
stock = $100 par value × 4% = $4 per share.

Cumulative Dividend:
* Preferred stock often contains a cumulative feature. This means that
preferred stockholders must be paid both current and prior years dividends
before common stockholders receive any dividends.

* When preferred stock is cumulative, preferred dividends not declared are

called dividends in arrears.

* Dividends in arrears are not considered a liability. No payment obligation

exists until a dividend is declared by the board of directors. However, the
amount of the dividends in arrears should be disclosed in the notes to the
financial statements.

Example:
Assume that Scientific-Leasing has 5,000 shares of 7%, $100 par value
cumulative preferred stock outstanding. The annual dividend is $ 35,000
(5,000 shares x $100 par value x 7%). If dividends were two years in arrears,
preferred stockholders are entitled to receive the following dividends before
any dividends are paid to common stockholders.

Dividends in arrears ($35000 × 2) $70000

Current-year dividends 35000

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Total preferred dividends $105000

Stockholders’ Equity Presentation:

• Stockholders’ equity section of the balance sheet
– Paid-in capital and retained earnings are reported.
– specific sources of paid-in capital are identified
• Paid-in capital:
– Capital stock.
– Additional paid-in capital.

Book Value Per Share Formula:

• Represents the equity a common stockholder has in the net assets
of the corporation from owning one share of stock.

• Formula for computing book value per share if corporation has

only one class of stock is:

Book Value per Share = Total stockholders’ equity / Number of common shares outstanding

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