Week 1 Lecture Notes
Welcome to week 1. This week we will cover chapter 13. Below is an overview of the most important concepts, which I have pulled from the chapter. You are also responsible for reading the chapter. Let’s get started…
Chapter 13
Corporations: Organization, Stock Transactions, and Dividends
Objectives: (will differ slightly from text):
1. Describe the nature of the corporate form organization.
2. Describe the two main sources of stockholders’ equity.
3. Prepare financial statement presentations of stockholders' equity.
4. List the major sources of paid-in capital, including the various classes of stock.
5. Journalize the entries for issuing stock, treasury stock, transactions, cash dividends and stock dividends.
6. State the effect of stock splits on corporate financial statements.
7. Journalize the entries for corporate income taxes, including deferred income taxes. (APPENDIX D of your Textbook-back of book)
8. Prepare a corporate balance sheet
Chapter 13 Overview: This chapter explains the characteristics of a corporation, also known as a "C" Corporation. It also introduces many of the terms related to stock: common, preferred, par value, stated value, no-par, cumulative, noncumulative, participating, and nonparticipating. Additional topics covered in Chapter 13 are treasury stock (cost method), stock splits, and dividends.
Objective 1: Describe the nature of the corporate form
organization
Corporation: A legal entity distinct and separate from the individuals who create and operate it. Chapter 13 opens with the characteristics of a corporation. Characteristics of a Corporation include:
1. Separate legal existence
2. Ownership evidenced by shares of stock
3. Ownership is easily transferred through sale of stock
4. Limited liability
5. Owners elect a board of directors to set corporate policies and select officers to manage the corporation
6. Separate taxable entity (leading to double taxation)
7. Earnings distributed in the form of dividends
Key Points:
The stockholders or shareholders who own the stock, also own the corporation.
The stockholders of a corporation have limited liability-
Forming a Corporation
To begin the process of forming a corporation, a business must file an application of incorporation with the state. After approving the application, the state grants a charter (or articles of incorporation) which formally creates the corporation. By-laws are the rules and procedures for conducting the corporation’s affairs.
Organization Costs
To begin the process of forming a corporation, a business must file an application of incorporation with the state. After approving this application, the state grants a charter (or articles of incorporation) that formally creates the corporation.
Organization costs are the costs incurred during the process of incorporating a business. These costs can be significant. They include the following:
Organization costs are recorded as an expense as they are incurred.
Example of journal entry to record organizational costs:
Hoover Corporation was organized early in 2004. Legal costs and other fees associated with incorporation totaled $3,500.
Organization Expenses 3,500 Cash
3,500
Objective 2: Describe the two main sources of stockholders’ equity.
The two sources of owner's equity are as follows:
Stockholders’ Equity = Assets – Liabilities
Example: What is the total stockholders' equity based on the following data?
|
Common Stock |
$900,000 |
|
Excess of Issue Price Over Par |
275,000 |
|
Retained Earnings (deficit) |
40,000 |
Answer: (900,000 + 275,000) – 40,000 = $1,135,000
Objective 3: Prepare financial statement presentations of stockholders' equity.
Page 589 of the textbook illustrates how the stockholder's equity section of the balance sheet should be prepared.
Objective 4: List the major sources of paid-in capital, including the various classes of stock.
The state charter allows a corporation to issue only a certain number of shares of each class of stock. This amount of stock is called authorized stock. Par is the monetary amount assigned to shares of stock. Stock issued without par is called no-par stock. Legal capital is the amount invested by shareholders, which cannot be returned in the form of dividends. Stock that is "issued" has been sold to stockholders. Stock is "outstanding" if it is still owned by stockholders. Stock that has been reacquired by a corporation (introduced in Objective 5 as treasury stock) is issued, but it is not outstanding. This can be expressed through the following equation:
Issued Stock - Stock Reacquired (Treasury Stock) = Outstanding Stock
Example: XYZ Corporation is authorized to sell 1 million shares of common stock; 750,000 shares have been issued, and 50,000 shares have been reacquired by XYZ. How many shares are outstanding? Answer: $700,000
Classes of Stock
Common Stock
The most common class of stock is called common stock. The major rights usually granted to a common shareholder are:
Preferred Stock
Note that dividends are not a liability of a corporation until declared by the board of directors. Corporations are not required to pay dividends. If a corporation determines that it needs to keep its earnings to finance growth, or if earnings are low, the preferred dividend may be passed in one or more years. These passed dividends are called dividends in arrears. If the preferred stock is cumulative, all dividends in arrears must be paid before any dividends are granted to the common shareholder. If the preferred stock is noncumulative, the preferred stockholder forfeits any passed dividends. In nonparticipating preferred stock, the shareholders will receive only their regular dividend, with all additional dividends going to the common shareholder.
*Investors in common stock run a greater risk of not receiving dividends than do investors in preferred stock. On the other hand, common stock investors have a greater potential for earning more dividends than do investors in preferred stock.
Example: Distributing Dividends
Belson Corporation has 10,000 common shareholders and 5,000 preferred shareholders. The preferred stock has a $5 dividend rate. Two years of dividends are currently in arrears.
Assume that the preferred stock is cumulative and nonparticipating. Belson has $155,000 to distribute in the form of dividends. Use this information to calculate the dividends distributed to the preferred and common shareholders.
| Preferred Shareholders |
Common Shareholders |
Total Distributed |
|
| Dividends in arrears (5,000 x $5 x 2) | $50,000 | $50,000 | |
| Regular dividend | 25,000 | 75,000 | |
| Remainder | $80,000 | 155,000 | |
|
$75,000 | $80,000 | |
| Per share dividends | $15 | $8 | . |
Objective 5: Journalize the entries for issuing stock, treasury stock, transactions, cash dividends and stock dividends.
When stock has sold at a premium, then the stock has been issued for a price greater than its par; a discount indicates that stock was issued for a price less than its par.
Examples of journalizing entries:
Issuing capital stock:
Belson Corporation sold 1,000 shares of $10 par value common stock for $17 per share.
Cash………………………………………………………….…… 17,000
Common Stock…………………………………………… 10,000
Paid-in Capital in Excess of Par—Common Stock………. 7,000
Belson sold 1,000 shares of $25 par value preferred stock for $30 per share.
Cash………………………………………………………………. 30,000
Preferred Stock…………………………………………… 25,000
Paid-in Capital in Excess of Par—Preferred Stock………. 5,000
Treasury Stock:
Lawry purchased 1,000 shares of $5 par value common stock for $10 per share.
Treasury Stock…………………………………….. 10,000
Cash……………………………………….. 10,000
Lawry sold 100 shares of its treasury stock at $12 per share.
Cash……………………………………………….. 1,200
Treasury Stock…………………………….. 1,000
Paid-in Capital from Sale of Treasury Stock 200
The term "treasury stock" originated because the treasurer’s office of a corporation usually has the responsibility for purchasing and maintaining custody of such stock. The text presents the cost method of accounting for treasury stock. The par value method is mentioned only in a footnote.
The treasury stock account is a contra equity account, reducing shareholders’ equity for the amount returned to shareholders through the purchase of treasury stock. Many students are under the false impression that treasury stock is an asset, because it has a debit balance. A corporation does not (1) pay dividends on treasury stock, (2) vote treasury stock, or (3) recognize gains or losses if the treasury stock is reissued. Therefore, a corporation does not purchase its own stock as an investment and it is not recorded as an asset.
Treasury stock is the only "stock" account that is not recorded at par. The cost of treasury stock, not the par value, is debited to the account.
Cash dividend:
On January 15, the Board of directors of Barns Incorporated declared a $0.25 per-share dividend on its common stock to shareholders of record on January 31, payable on February 15. Barns has 25,000 shares of stock authorized, 10,000 shares issued, and 8,000 shares outstanding.
1. Date of Declaration: Once declared, the dividend becomes a liability of the corporation.
Therefore, it is credited to a liability account.
January 15 Cash Dividends………………….. 2,000
Cash Dividends Payable…. 2,000
The cash dividends account is the corporate counterpart to the sole proprietor's drawing account. It is closed to retained earnings at year end.
Also note that the total dollar amount of the dividend is $2,000 (8,000 shares x $0.25). Dividends are not paid on the 2,000 treasury shares.
2. Date of Record: No journal entry is required. This date determines who will receive the dividend. Anyone owning stock in Barns at the close of business that day will receive the dividend.
3. Date of Payment: The liability is paid by mailing the dividend checks.
February 15 Cash Dividends Payable…………. 2,000
Cash……………………… 2,000
Stock dividend:
On June 20, the board of directors of Carlisle Corp. declares a 4% stock dividend on its 50,000 shares of common stock. The shares will be issued on July 14. The par value of the stock is $10 per share; the market value on June 20 is $16 per share.
1. Declaration Date: A liability to distribute the dividends is established with a credit to the stock dividends distributable account.
June 20 Stock Dividends………………………………… 32,000
Stock Dividends Distributable………….. 20,000
Paid-in Capital in Excess of Par
—Common Stock…………………….. 12,000
2. Distribution Date: The additional shares are mailed to the shareholders, relieving the corporation's liability. The shares are recorded as outstanding by crediting the common stock account.
July 14 Stock Dividends Distributable…………… 20,000
Common Stock…………………… 20,000
Stock Dividends
When stock dividends are "paid," additional shares of stock are mailed to the shareholders. This allows the corporation to give a return to its shareholders without using any of its cash.
In reality, shareholders own exactly the same portion of the corporation after the stock dividend as they did before the dividend was issued. You can compare the corporation to a pie. Let’s say that you cut a pie into six pieces. If you have three pieces, you have half of the pie. If you originally cut that same pie into eight pieces, four pieces equal half the pie. Four pieces may seem like more than three, but because they are smaller pieces, you still get the same amount of dessert (and calories).
A corporation issuing a stock dividend doesn’t get any bigger because the dividend doesn’t bring in any new assets. The corporation also doesn’t get any smaller because a stock dividend doesn’t use up any assets. The corporation is just divided into smaller pieces. All shareholders have more pieces, but they’re still getting the same share of the pie.
How do shareholders profit from stock dividends? In theory, a 10 percent stock dividend should reduce the market price of the stock by 10 percent since each share represents a 10 percent smaller piece of the pie. However, in many cases, the market price of the stock does not decline the full 10 percent. Therefore, the total market value of each shareholder’s stock increases.
Even if the market price does fall the full 10 percent, shareholders have more shares on which to realize any future share appreciation. They also have more shares on which to receive any future cash dividend payments.
Objective 6: State the effect of stock splits on corporate financial statements
With a stock split, one share of stock is split into two or more shares. When this occurs, the par value of the stock decreases, and the number of shares increases. The market value of the stock should also fall. Stock splits tend to be very good for shareholders. The split will lower the price, making stock affordable for more investors. More investors will enter the market, creating demand. Additional demand will begin to drive the stock price back up, and the shareholders enjoy the profits resulting from the share appreciation.
No journal entry is required for a stock split.
Objective 7: Journalize the entries for corporate income taxes, including deferred income taxes. (APPENDIX D of your Textbook-back of book)
Companies must estimate their tax liability based on projections of sales and expenses. Taxes are paid through four quarterly installments, due on April 15, June 15, September 15, and January 15.
Example: For example, Brava Corporation has made the following projections for 2004:
Sales $1,000,000
Expenses 850,000
Taxable Income $ 150,000
Tax rate = 40%
The amount of taxes that Brava will have to pay for 2004 based on the corporation's projections is calculated as follows: 150,000 X .40 = $60,000
Next, we need to calculate the amount that Brava will pay in each quarterly installment: $60,000/4 = $15,000
The journal entry to record a quarterly tax payment:
Income Tax Expense…..… 15,000
Cash……………… 15,000
Now let’s assume that Brava actually has $180,000 in taxable income at the end of 2004. The total tax liability using a 40% tax rate will actually be $72,000. At this point you will record any taxes that Brava owes in addition to the amounts paid through quarterly installments. Assume that Brava will not pay these taxes immediately, but will wait until they are due to pay them. The journal entry is as follows:
Income Tax Expense…….. 12,000
Income Tax Payable 12,000
Certain revenues and expenses may be recorded differently on a corporation's financial statements than on its tax return. These differences occur because of the following reasons:
Example: The income before income tax for the first year of operations is $550,000. Because of timing differences in accounting and tax methods, the taxable income for the same year is $350,000. Assuming an income tax rate of 50%, the amount of the deferred income tax would be? Answer: $100,000
Objective 8: Prepare a corporate balance sheet.
The preparation of the corporate balance sheet can be viewed throughout chapter 13. Page 708 of the textbook has a complete balance sheet to view.
Week 1 Checklist:
Read and submit syllabus
Read the week 1 announcement
Submit Codename for gradebook-read more about this in the week 1 announcement
Read Chapter 13
View Chapter 13 PowerPoint Presentation
Read Lecture notes
Complete assigned problems- (Chapter 13: PE 13-2A, PE 13-3A, PE 13-4A, PE 13-5A)
Participate in Discussion Question
Supplemental Material
Lesson One Web PowerPoint -- Chapter 13
Lesson One PowerPoint Handout -- Abode format -- Chapter 13
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