ACC101- PRINCIPLE OF ACCOUNTING

Session 26
CHAPTER 13: ACCOUNTING FOR CORPORATIONS

1
 OBJECTIVES

COMMON STOCK
C1 Identify characteristics of corporations and their organization.
P1 Record the issuance of corporate stock.
DIVIDENDS
P2 Record transactions involving cash dividends, stock dividends, and stock splits.
PREFERRED STOCK
C2 Explain characteristics of, and distribute dividends between, common and preferred stock.
TREASURY STOCK
P3 Record purchases and sales of treasury stock and the retirement of stock.
REPORTING & ANALYSIS
C3 Explain the items reported in retained earnings.
A1 Compute earnings per share, price-earnings ratio, dividend yield, book value and describe its use in analysis.

2
 1. Bond Basics
A1 1.1. Bond Financing
Advantages Disadvantages

Bonds do not affect stockholder

control. Requires payment of both periodic
interest and par value at maturity.

ROE  when the Interest on bonds is tax deductible.

expected rate of return Can decrease return on equity
from the new assets > when the company pays more in
interest rate on the debt Bonds can increase return on interest than it earns on the
financing equity. borrowed funds.
 1. Corporate Form of Organization
C1

An entity created
by law

Existence is
Privately Held
Ownership
separate from
owners can be

Has rights and

privileges
Publicly Held
 1. Corporate Form of Organization
C1 1.1. Characteristics of Corporations

Advantages
▪ Separate legal entity
▪ Limited liability of stockholders
▪ Transferable ownership rights
▪ Continuous life
▪ Lack of mutual agency for stockholders
▪ Ease of capital accumulation
Disadvantages
▪ Governmental regulation
▪ Corporate taxation
 1. Corporate Form of Organization
C1 1.2. Corporate Organization and Management

Stockholders

Board of Directors

President, Vice-President, and

Other Officers

Employees of the Corporation

 1. Corporate Form of Organization
C1 1.2. Corporate Organization and Management

Corporate Organization Chart

Stockholders
Ultimate
Stockholders usually meet
control.
once a year.
Selected by a
Board of Directors Overall
vote of the
responsibility for
stockholders.
managing the
President company.

Secretary Vice President Vice President Vice President

Finance Production Marketing
 1. Corporate Form of Organization
C1 1.3. Stockholders of Corporations

Rights of Stockholders
Vote at stockholders’ meetings
Sell stock
Purchase additional shares of stock (preemptive right)
Receive dividends, if any
Share equally in any assets remaining after creditors are
paid in a liquidation
 1. Corporate Form of Organization
C1 1.3. Stockholders of Corporations
Stock Certificates and Transfer

Each unit of ownership is

called a share of stock.
A stock certificate serves
as proof that a stockholder
has purchased shares.

When the stock is sold, the stockholder signs a transfer endorsement

on the back of the stock certificate.
 1. Corporate Form of Organization
C2 1.4. Basics of Capital Stock

Total amount of stock that a corporation’s charter authorizes it to sell.

Stockholders' Equity
Common Stock, par value $.01;
authorized 250,000,000 shares; issued
and outstanding 92,556,295 shares $925,563

Total amount of stock that has been issued or sold to stockholders.

 1. Corporate Form of Organization
C2 1.4. Basics of Capital Stock


Par value is an arbitrary
Market price is the amount
amount assigned to each
that each share of stock
share of stock when it is
will sell for in the market.
authorized.

Classes of Stock
▪ Par Value
▪ No-Par Value
▪ Stated Value
 2. Common Stock
P1
2.1. Issuing Par Value Stock
Issuing Par Value Stock at Par

Par Value Stock

On September 1, Matrix, Inc. issued 100,000 shares of $2 par
value stock for $2 per share. Let’s record this transaction.

Dr Cr
Sept. 1 Cash 200,000
Common Stock, $2 par value 200,000
Issued 100,000 shares of $2 par value common stock at par.
 2. Common Stock
P1
2.1. Issuing Par Value Stock
Issuing Par Value Stock at a Premium
Par Value Stock
On September 1, Matrix, Inc. issued 100,000 shares of $2 par
value stock for $25 per share. Let’s record this transaction.

Dr Cr
Sept. 1 Cash 2,500,000
Common Stock, $2 par value 200,000
Paid-in Capital in Excess
of Par Value, Common 2,300,000
Issued 100,000 shares of common stock.
 2. Common Stock
P1 2.1. Issuing Par Value Stock
Issuing Par Value Stock at a Premium

Stockholders' Equity with Common Stock

Stockholders' Equity
Common Stock - $2 par value; 500,000 shares
authorized; 100,000 shares issued and
outstanding $ 200,000
Paid-In Capital in Excess of Par 2,300,000
Retained earnings 650,000
Total stockholders' equity $ 3,150,000
 2. Common Stock
P1 2.2. Issuing Stock for Noncash Assets

Par Value Stock

On September 1, Matrix, Inc. issued 100,000 shares of $2 par value
stock for land valued at $2,500,000. Let’s record this transaction.

Dr Cr
Sept. 1 Land 2,500,000
Common Stock, $2 par value 200,000
Paid-in Capital in Excess 2,300,000
of Par Value, Common
Exchanged 100,000 common shares for land
 2. Common Stock
P1 2.2. Issuing Stock for Noncash Assets

A corporation sometimes gives shares of its stock to promoters in

exchange for their services in organizing the corporation, which
the corporation records as organization expenses.
 3. Dividends
P2 3.1. Cash Dividends
Regular cash dividends provide a return to investors and almost always
affect the stock’s market value.

Corporation Dividends Stockholders

To pay a cash dividend the % of Corporations Paying Divends

corporation must have: 100%
75%
80%
1. A sufficient balance in 60%
retained earnings and 40%
22%
20%
2. The cash necessary to pay 0%
the dividend. Common Preferred
 3. Dividends
P2 3.1. Cash Dividends
Three important dates

Date of Declaration Date of Record Date of Payment

Record liability No entry Record payment of
for dividend. required. cash to stockholders.
 3. Dividends
P2 3.1. Cash Dividends

On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s

10,000 common shares outstanding. The dividend will be paid on March
19 to stockholders of record on February 19.

Date of Declaration
Record liability for dividend.

Dr Cr
Jan. 19 Retained Earnings 10,000
Common Dividend Payable 10,000
Declared $1 per share cash dividend
 3. Dividends
P2 3.1. Cash Dividends
On January 19, a $1 per share cash dividend is declared on Dana, Inc.’s
10,000 common shares outstanding. The dividend will be paid on March 19
to stockholders of record on February 19.
No entry required on February 19, the date of record.

Date of Payment
Record payment of
cash to stockholders.

Dr Cr
Mar. 19 Common Dividends Payable 10,000
Cash 10,000
Paid $1 per share cash dividend
 3. Dividends
P2 3.1. Cash Dividends
Deficits and Cash Dividends
A debit (abnormal) balance for Retained Earnings (retained earnings deficit)
is created when a company incurs cumulative losses or pays dividends
greater than total profits earned in other years.
Dana, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2009
Stockholders' Equity
Common stock $10 par value,
10,000 shares authorized and outstanding $ 100,000
Retained earnings deficit (8,500)
Total stockholders' equity $ 91,500
 3. Dividends
P3 3.2. Stock Dividends

A distribution of a corporation’s own shares to its stockholders without

receiving any payment in return.
Why a stock dividend?
▪ Can be used to keep the market price on the stock affordable.
▪ Can provide evidence of management’s confidence that the company is doing well.
Small Stock Dividend
Distribution is  25% of the previously outstanding shares.
Large Stock Dividend
Distribution is > 25% of the previously outstanding shares.
100 shares
HotAir, Inc.
Common Stock$1 par
 3. Dividends
P3
3.2. Stock Dividends Recording a Small Stock Dividend

Quest has 100,000 shares of $1 par value stock outstanding. On December

31, 2009, Quest declared a 2% stock dividend, when the stock was selling
for $10 per share. The stock will be distributed to stockholders on January
20, 2010. Let’s make the December 31 entry.

Capitalize retained earnings for the market value of

the shares to be distributed. (100,000 × 2% = 2,000 × $1 par
2,000 × $10 = $20,000)
Dr Cr
Dec. 31 Retained Earnings 20,000
Common Stock Dividend Distributable 2,000
Paid-In capital in excess
of Par Value 18,000
Declared a 2,000 share (2%) stock dividend
 3. Dividends
P3 3.2. Stock Dividends Recording a Small Stock Dividend
Quest, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2009

Common stock - $1 par value,

Before the 250,000 shares authorized,
100,000 shares issued and outstanding $ 100,000
stock Paid-in capital in excess of par value 8,000
Total paid-in capital $ 108,000
dividend. Retained earnings 35,000
Total stockholders' equity $ 143,000

Quest, Inc.
Balance Sheet (Stockholders' Equity Section)
December 31, 2009

Com m on s tock - $1 par value ,

After the
250,000 s hare s authorize d,
100,000 s hare s is s ue d and outs tanding $ 100,000 stock
Com m on s tock divide nd dis tributable , 2,000 s hare s
Total com m on s tock is s ue d and to be is s ue d $
2,000
102,000
dividend.
Paid-in capital in e xce s s of par value 26,000
Total Paid-in capital $ 128,000
Re taine d e arnings 15,000
Total s tock holde rs ' e quity $ 143,000
 3. Dividends
P3
3.2. Stock Dividends Recording a Large Stock Dividend

Router, Inc., has 50,000 shares of $1 par value stock outstanding. On

December 31, 2009, Router declared a 40% stock dividend, when the stock
was selling for $8 per share. The stock will be distributed to stockholders
on January 20, 2010. Let’s make the December 31 entry.

Capitalize retained earnings for the minimum amount required by

state law, usually par or stated value of the shares.
(50,000 × 40% = 20,000 shares × $1 par value = $20,000)

Dr Cr
Dec. 31 Retained Earnings 20,000
Common Stock Dividend Distributable 20,000
Declared a 20,000 share (40%) stock dividend
 3. Dividends
P3 3.3. Stock Splits

A distribution of additional shares of stock to stockholders according to

their percent ownership.
$10 par value
Old
Common Stock
Shares
100 shares

$5 par value
New
Shares Common Stock
200 shares
 4. Preferred Stock
C3

A separate class of stock, typically having priority over common

shares in . . .
▪ Dividend distributions
▪ Distribution of assets in case of liquidation

Usually has a stated dividend Normally has no

rate voting rights
Corporations
73% with no
Preferred Stock
Corporations
with Preferred
Stock

27%
 4. Preferred Stock
C3
4.1. Issuance of Preferred Stock

If Dillon Snowboards issues 50 shares of $100 par value preferred stock for
$6,000 cash on July 1, 2015,
 4. Preferred Stock
P4 4.2. Dividend Preference of Preferred Stock
Cumulative vs. Noncumulative
Dividends in arrears must be Undeclared dividends from
paid before dividends may be current and prior years do not
paid on common stock. have to be paid in future years.
(Normal case)

Consider the following Stockholders’ Equity Section of the Balance Sheet. The
Board of Directors did not declare or pay dividends in 2009. In 2010, the
Board declared and paid cash dividends of $42,000.
Common stock, $5 par value; 40,000 shares
authorized, issued and outstanding $ 200,000
Preferred stock, 9%, $100 par value; 1,000
shares authorized, issued and outstanding 100,000
Total Paid-In capital $ 300,000
 4. Preferred Stock
P4
4.2. Dividend Preference of Preferred Stock

If Preferred Stock is Noncumulative: Preferred Common

Year 2009: No dividends paid. $ - $ -
Year 2010:
1. Pay 2010 preferred dividend. $ 9,000
2. Remainder goes to common. $ 33,000

If Preferred Stock is Cumulative: Preferred Common

Year 2009: No dividends paid. $ - $ -
Year 2010:
1. Pay 2009 preferred dividend in arrears. $ 9,000
2. Pay 2010 preferred dividend. 9,000
3. Remainder goes to common. $ 24,000
Totals $ 18,000 $ 24,000
 4. Preferred Stock
P4 4.2. Dividend Preference of Preferred Stock
Participating vs. Nonparticipating
Dividends may exceed a stated Dividends are limited to a
amount once common maximum amount each year. The
stockholders receive a dividend maximum is usually the stated
equal to the preferred stated dividend rate.
rate. (Normal case)
Reasons for Issuing Preferred Stock
▪ To raise capital without sacrificing control
▪ To boost the return earned by common stockholders through
financial leverage
▪ To appeal to investors who may believe the common stock is too
risky or that the expected return on common stock is too low
 5. Treasury Stock
P5

Treasury stock represents shares of a company’s own stock that

has been acquired. Corporations might acquire its own stock to:
1.Use their shares to buy other companies.
2.Avoid a hostile takeover.
3.Reissue to employees as compensation.
4.Support the market price.

Corporations and Treasury Stock

No Treasury Stock
38%

With Treasury
Stock
62%
 5. Treasury Stock
P5
5.1. Purchasing Treasury Stock

On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in

the open market for $4 per share.
Dr Cr
May 8 Treasury stock, common 8,000
Cash 8,000
Purchase 2,000 treasury shares
at $4 per share

Treasury stock is shown as a reduction in total

stockholders’ equity on the balance sheet.
 5. Treasury Stock
P5
5.2. Selling Treasury Stock at Cost

On June 30, Whitt sold 100 shares of its treasury stock for $4 per share.

Dr Cr
June 30 Cash 400
Treasury stock, common 400
Sold 100 shares of treasury
for $4 per share
 5. Treasury Stock
P5 5.3. Selling Treasury Stock Above Cost

On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for
$8 per share.

Dr Cr
July 19 Cash 4,000
Treasury Stock, common 2,000
Paid-In Capital, Treasury Stock 2,000
Sold 500 treasury shares for $8 per share

Shares Per Share Total

Sale 500 $ 8.00 $ 4,000
Cost 500 4.00 2,000
Paid-In Capital $ 2,000
 5. Treasury Stock
P5 5.4. Selling Treasury Stock Below Cost

On August 27, Whitt sold an additional 400 shares of its treasury

stock for $1.50 per share.

Dr Cr
Aug. 27 Cash 600
Paid-in Captial, Treasury Stock 1,000
Treasury Stock, Common 1,600
Sold 500 treasury shares for $1.50 per share

Shares Per Share Total

Cost 400 $ 4.00 $ 1,600
Sale 400 1.50 600
Difference $ 1,000
 6. Reporting Of Equity
C4 6.1. Statement of Retained Earnings

Retained earnings is the total cumulative amount of reported net income less
any net losses and dividends declared since the company started operating.

Restricted Retained Earnings

Legal Restriction Contractual Restriction

Most states restrict Loan agreements
the amount of can include
treasury stock restrictions on paying
purchases to the dividends below a
amount of retained certain amount of
earnings. retained earnings.
 6. Reporting Of Equity
C4
6.1. Statement of Retained Earnings
Appropriated Retained Earnings

A corporation’s directors can voluntarily limit dividends because of a special

need for cash such as the purchase of new facilities.

Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2010

Retained earnings, 1/1/10 $ 875,000

Plus: net income 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/10 $ 950,600
Appropriated retained earnings (450,000)
Unappropriated retained earnings $ 500,600
 6. Reporting Of Equity
C4 6.1. Statement of Retained Earnings
Prior Period Adjustments
Prior period adjustments are correction of material errors in past years’ financial
statements that result in a change in the beginning balance of retained earnings.

Reed, Inc.
Statement of Retained Earnings
For Year Ended December 31, 2010

Retained earnings, 12/31/09, as previously reported $ 875,000

Prior period adjustment: Cost of equipment
incorrectly expensed (net of $28,000 income taxes) 72,000
Retained earnings, 12/31/09, as adjusted 947,000
Plus: net income 155,600
Less: dividends declared (80,000)
Retained earnings, 12/31/10 $ 1,022,600
 6. Reporting Of Equity
C4 6.2. Statement of Stockholders’ Equity

Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2010

Common stock and

(In millions) capital in excess of par Retained
Shares Amount Earnings Total
Balance at January 1, 2010 821 $ 2,500 $ 9,500 $ 12,000
Stock sales 17 500 500
Stock repurchases and retirement (17) (260) (925) (1,185)
Cash dividends declared (150) (150)
Other, net 70 70
Net income 5,100 5,100
Balance at December 31, 2010 821 $ 2,740 $ 13,595 $ 16,335

This is a more inclusive statement than the statement of retained earnings.

 6. Reporting Of Equity
C4 6.3. Stock Options

The right to purchase common stock at a fixed price over a specified

period of time. As the stock’s price rises above the fixed option price,
the value of the option increases.

Market
Option price of
purchase stock $75
price $30 per share.
per share.
Options are given to key employees to motivate them to:
⚫ focus on company performance,
⚫ take a long-run perspective, and
⚫ remain with the company.
 Earnings Per Share
A1

Earnings per share is one of the most widely cited items of

accounting information.

Basic
earnings = Net income - Preferred dividends
per share Weighted-average common shares outstanding
 Price–Earnings Ratio
A2
This ratio reveals information about the stock market’s
expectations for a company’s future growth in earnings,
dividends, and opportunities.

Price–
Market value per share
Earnings =
Earnings per share
Ratio
If earnings go up,
will the market price
of my stock follow?
 Dividend Yield

A3
Tells us the annual amount of cash dividends distributed to
common stockholders relative to
the stock’s market price.

Dividend Annual cash dividends per share

=
Yield Market value per share
 Book Value per Share–Common
A4

Reflects the amount of stockholders’ equity

applicable to common shares on a per share basis.

Stockholders’ equity applicable

Book value per to common shares
=
common share Number of common
shares outstanding
 Book Value per Share–Preferred
A4

Records amount of stockholders’ equity applicable

to preferred shares on a per share basis.

Stockholders’ equity applicable

Book value per to preferred shares
=
preferred share Number of preferred shares
outstanding
Homework

HOMEWORK:
MCQs for review list

47