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Chapter 12

Corporations: Organization,
Capital Stock Transactions,
and Dividends
Accounting, 21st Edition
Warren Reeve Fess

© Copyright 2004 South-Western, a division


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Professor Emeritus of Accounting
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Objectives
Objectives
1. Describe the nature of the corporate form of
After
organization.After studying
studying this
this
chapter, you should
2. List the two main sourcesshould
chapter, you of stockholders’
equity. be
be able
able to:
to:
3. List the major sources of paid-in capital,
including the various classes of stock.
4. Journalize the entries for issuing stock.
5. Journalize the entries for treasury stock
transactions.
Objectives
Objectives
6. State the effect of stock splits on
corporate financial statements.
7. Journalize the entries for cash
dividends and stock dividends.
8. Describe and illustrate the reporting of
stockholders’ equity.
9. Compute and interpret the dividend
yield on common stock.
Organizational
Organizational Structure
Structure of
of aa Corporation
Corporation
Stockholders
(owners of corporation stock)

Board of Directors
(elected by stockholders)

Officers
(selected by board of directors)

Employees
Forming
Forming aa Corporation
Corporation
 First step is to file an application of incorporation with the state.
 Because state laws differ, corporations often organize in states with more
favorable laws.
 More than half of the largest companies are incorporated in Delaware.
 State grants a charter or articles of incorporation which formally create
the corporation.
 Management and board of directors prepare bylaws which are operation
rules and procedures.
Forming
Forming aa Corporation
Corporation
On
On January
January 5, 5, the
the firm
firm paid
paid the
the organization
organization
costs
costs ofof $8,500.
$8,500. This
This amount
amount includes
includes legal
legal
fees,
fees, taxes
taxes and
and licenses,
licenses, promotion
promotion costs,
costs, etc.
etc.
Jan. 5 Organization Costs 8 500 00
Cash 8 500 00
Paid cost of organizing the
corporation.
Stockholders’
Stockholders’ Equity
Equity
Liabilities
Assets
Stockholders’
Stockholders’
Equity
Equity

Stockholders’ Equity = Assets – Liabilities


Represents the stockholders’ share of the total assets.
Stockholders’
Stockholders’ Equity
Equity
Liabilities
There
There are
are two
Assets two
sources of Stockholders’
Stockholders’
sources of
Equity
Equity
stockholders’
stockholders’ equity.
equity.
Stockholders’
Stockholders’ Equity
Equity
Liabilities
Assets
Stockholders’
Stockholders’
Equity
Equity

Stockholders’ Equity: 1
Paid-in capital: Stockholder
Common stock $xxxxx investments

Retained earnings xxxx


Total $xxxxx
Stockholders’
Stockholders’ Equity
Equity
Liabilities
Assets
Stockholders’
Stockholders’
Equity
Equity

Stockholders’ Equity:
Paid-in capital:
Common stock $xxxxx 2
Retained earnings xxxx Reinvested
Total $xxxxx earnings
Sources
Sources of
of Paid-In
Paid-In Capital
Capital
Authorized

Issued

Outstanding

Number of Shares
Sources
Sources of
of Paid-In
Paid-In Capital
Capital
Major
Major Rights
Rights that
that
Accompany
Accompany Ownership
Ownership
of
of aa Share
Share of
of Stock
Stock
1. The right to vote in matters
concerning the corporation.
2. The right to share in
distribution of earnings.
3. The right to share in assets on
liquidation.
Classes
Classes of
of Stockholders
Stockholders
The two primary classes of paid-in capital are
common stock and preferred stock. The
primary attractiveness of preferred stocks is that
they are preferred over common as to dividends.

Preferred Common
Money Stockholders Stockholders
available
for
dividends
Classes
Classes of
of Stockholders
Stockholders
Common Stock—the basic ownership of stock with rights to
vote in election of directors, share in distribution of
earnings, and purchase additional shares.
Preferred Stock—A class of stock with preferential rights
over common stock in payment of dividends and company
liquidation.
Nonparticipating
Nonparticipating Preferred
Preferred Stock
Stock
A nonparticipating preferred stock is limited to a
certain amount. Assume 1,000 shares of $4
nonparticipating preferred stock and 4,000 shares
of common stock and the following:
2005 2006 2007
Net income $20,000 $55,000 $62,000
Amount retained 10,000 20,000 40,000
Amount distributed $10,000 $35,000 $22,000
Nonparticipating
Nonparticipating Preferred
Preferred Stock
Stock
Amount distributed $10,000 $35,000 $22,000
Preferred dividend
(1,000 shares) 4,000 4,000 4,000
Common dividend
(4,000 shares) $6,000 $31,000 $18,000
Dividends per share:
Preferred $ 4.00$ 4.00$ 4.00
Common $ 1.50$ 7.75$ 4.50
Cumulative
Cumulative Preferred
Preferred Stock
Stock
So,
So, preferred
preferred
dividends
dividends are
are two
two
years
years in
in arrears.
arrears.
Assume 1,000 shares of $4
cumulative preferred stock
and 4,000 shares of common
stock. No dividends were
paid in 2005 and 2006.
Cumulative
Cumulative Preferred
Preferred Stock
Stock

On March 7, 2007, the board of directors


declares dividends of $22,000.
Cumulative
Cumulative Preferred
Preferred Stock
Stock
Preferred
Preferred Stock
Stock Dividends
Dividends Dividends
Dividends Paid
Paid in
in 2007
2007
Total dividends paid,
$22,000

$4,000 $4,000

2005
(In arrears) $4,000 $4,000 $10,000
2006
(In arrears) $4,000 $4,000

2007 Preferred Common


(Current dividend) Stock Stock
Other
Other Sources
Sources of
of Paid-in
Paid-in Capital
Capital
On April 20 the city of Moraine donated
land to Merrick Corporation as an incentive
to relocate its headquarters to Moraine.
The land was valued at $500,000.
Apr. 20 Land 500 000 00
Donated Capital 500 000 00
Recorded land donated by the
city of Moraine.
Issuing
Issuing Stock
Stock
A corporation is authorized to issue 10,000
shares of preferred stock, $100 par, and
100,000 shares of common stock, $20 par.
Issuing
Issuing Stock
Stock
On
On April
April 1,
1, one-half
one-half of of each
each class
class of
of
authorized
authorized stock
stock isis issued
issued at
at par
par for
for cash.
cash.

Apr. 1 Cash 1,500000 00


Preferred Stock 500 000 00
Common Stock 1,000000 00
Issued preferred stock and
common stock at par.
Issuing
Issuing Stock
Stock
Common
Common Stock Stock andand Preferred
Preferred Stock
Stock accounts
accounts are
are
controlling
controlling accounts.
accounts. A
A record
record of
of each
each
stockholders’
stockholders’ name,name, address,
address, and
and number
number of of shares
shares
isis kept
kept in
in aa stockholders’
stockholders’ subsidiary
subsidiary ledger.
ledger.
Issuing
Issuing Stock
Stock at
at aa Premium
Premium
On
On March
March 15,
15, Caldwell
Caldwell Company
Company issues
issues 2,000
2,000
shares
shares of
of $50
$50 par
par preferred
preferred stock
stock for
for cash
cash at
at $55.
$55.

Mar. 15 Cash 110 000 00


Preferred Stock 100 000 00
Paid-in Capital in Excess of Par--
Preferred Stock 10 000 00
Issued 2,000 shares of $50 par
preferred stock at $55.
Issuing
Issuing Stock
Stock at
at aa Premium
Premium
When
When stock
stock isis issued
issued for
for more
more than
than
its
its par,
par, the
the stock
stock hashas sold
sold at
at aa
premium.
premium. ItIt has
has sold
sold at
at aa discount
discount ifif
issued
issued for
for less
less than
than its
its par.
par.
The
The $10,000
$10,000 excess
excess isis recorded
recorded in in aa
separate
separate account
account because
because some
some states
states do
do
not
not consider
consider this
this to
to be
be part
part of
of legal
legal
capital
capital and
and may
may bebe used
used for
for dividends.
dividends.
Issuing
Issuing Stock
Stock at
at aa Premium
Premium
On
On Nov.
Nov. 12,
12, aa corporation
corporation acquired
acquired land
land for
for which
which the
the fair
fair
market
market value
value cannot
cannot be
bedetermined.
determined. TheThe corporation
corporation
issued
issued 10,000
10,000 shares
shares of
of $10
$10 par
par common
common that
that has
has aa current
current
market
market value
value of
of $12
$12 in
in exchange
exchange for
for the
the land.
land.
Nov.12 Land 120 000 00
Common Stock 100 000 00
Paid-in Capital in Excess of Par 20 000 00
Issued $10 par common stock
valued at $12 per share, for
land.
Issuing
Issuing Stock
Stock at
at aa Premium
Premium
Stock issued for assets other than cash should be
recorded at the fair market value of the asset or
fair market value of the stock, whichever can be
more clearly determined.
Issuing
Issuing Stock
Stock at
at No-Par
No-Par
On
On February
February 23,
23, aa corporation
corporation issues
issues 10,000
10,000
shares
shares of
of no-par
no-par common
common stock
stock at
at $40
$40 aa share.
share.
Feb. 23 Cash 400 000 00
Common Stock 400 000 00
Issued 10,000 shares of no-par
common stock at $40.
Issuing
Issuing Stock
Stock at
at No-Par
No-Par
Later,
Later, on
on March
March 9,
9, the
the corporation
corporation
issues
issues 1,000
1,000 additional
additional shares
shares at
at $36.
$36.
Mar. 9 Cash 36 000 00
Common Stock 36 000 00
Issued 1,000 shares of no-par
common stock at $36.
Issuing
Issuing Stock
Stock at
at No-Par
No-Par

Some
Some states
states require
require that
that the
the entire
entire
proceeds
proceeds from
from the
the sale
sale of
of no-par
no-par
stock
stock be
be treated
treated as
as legal
legal capital.
capital.
Issuing
Issuing Stock
Stock at
at No-Par
No-Par
Also,
Also, no-par
no-par stock
stock may may be
be
assigned
assigned aa stated
stated value
value per
per
share.
share. The
The stated
stated value
value isis
recorded
recorded similar
similar to
to aa par
par value.
value.
Issuing
Issuing Stock
Stock with
with aa Stated
Stated Value
Value
On
On March
March 30,
30, issued
issued 1,000
1,000 shares
shares of
of no-par
no-par
common
common stock
stock at
at $40;
$40; stated
stated value,
value, $25.
$25.
Mar. 30 Cash 40 000 00
Common Stock 25 000 00
Paid-in Capital in Excess of
Stated Value 15 000 00
Issued 1,000 shares of no-par
common stock at $36; stated
value, $25.
Treasury
Treasury Stock
Stock Transactions
Transactions
Occasionally,
Occasionally, aa corporation
corporation buysbuys
back
back its
its own
own stock
stock forfor the
the purpose
purpose
of
of later
later reissuing
reissuing it.
it. This
This stock
stock isis
referred
referred toto as
as treasury
treasury stock.
stock.
Treasury
Treasury Stock
Stock Transactions
Transactions
Treasury stock is stock that:
1. has been issued as fully paid.
2. has been reacquired by the corporation.
3. has not been canceled or reissued.

A commonly used method of


accounting for treasury stock is the cost
method.
Treasury
Treasury Stock
Stock Transactions
Transactions
Cost Method
On
On January
January 5,5, aa firm
firm purchased
purchased 1,000
1,000
shares
shares of
of treasury
treasury stock
stock (common
(common stock,
stock,
$25
$25 par)
par) at
at $45
$45 per
per share.
share.
Jan. 5 Treasury Stock 45 000 00
Cash 45 000 00
Purchased 1,000 shares of
treasury stock at $45.
Treasury
Treasury Stock
Stock Transactions
Transactions
Cost Method
On
On June
June 2,
2, sold
sold 200
200 shares
shares of
of
treasury
treasury stock
stock atat $60
$60 per
per share.
share.
June 2 Cash 12 000 00
Treasury Stock 9 000 00
Paid-in Capital from sale of
Treasury Stock 3 000 00
Sold 200 shares of treasury
stock at $60.
Treasury
Treasury Stock
Stock Transactions
Transactions
Cost Method
On
On September
September 3,
3, sold
sold 200
200 shares
shares
of
of treasury
treasury stock
stock at
at $40
$40 per
per share.
share.
Sep. 3 Cash 8 000 00
Paid-in Capital from Sale of
Treasury Stock 1 000 00
Treasury Stock 9 000 00
Sold 200 shares of treasury
stock at $60.
Stock
Stock Splits
Splits
A
A corporation
corporation sometimes
sometimes reduces
reduces the
the par
par or
or
stated
stated value
value of
of their
their common
common stock
stock and
and
issues
issues aa proportionate
proportionate number
number of of additional
additional
shares.
shares. This
This isis called
called aa stock
stock split.
split.
Stock
Stock Splits
Splits

BEFORE AFTER 5-1


STOCK SPLIT STOCK SPLIT

4 shares, $100 par 20 shares, $20 par

$400 total par value $400 total par value


Stock
Stock Splits
Splits
A
A stock
stock split
split does
does not
not change
change the
the balance
balance
of
of any
any corporation
corporation accounts.
accounts. However,
However, itit
can
can make
make the
the stock
stock more
more attractive
attractive toto
investors
investors by
by reducing
reducing the
the price
price of
of aa
share,
share,
Accounting for Cash Dividends
 Dividends are distributions of retained earnings to
stockholders.
 Dividends may be paid in cash, stock, or property.
 Dividends, even on cumulative preferred stock, are
never required, but once declared become a legal
liability of the corporation.
Accounting for Cash Dividends
Corporations generally declare and pay cash dividends on
shares outstanding when three conditions exist:
1. Sufficient retained earnings

2. Sufficient cash

3. Formal action by the board of


directors
Retained Earnings
50,000
Accounting for Cash Dividends
There
There are
are three
three
important
important dates
dates relating
relating
the
the dividends.
dividends.
Accounting for Cash Dividends
First
First isis the
the date
date of
of declaration.
declaration.
Assume
Assume that that on
on December
December 1, 1,
Hiber
Hiber Corporation
Corporation declares
declares aa
$42,500
$42,500 dividend.
dividend.
Accounting for Cash Dividends

Date
Date of
of Declaration
Declaration

Dec. 1 Cash Dividends 42 500 00


Cash Dividend Payable 42 500 00
Declared cash dividend.
Accounting for Cash Dividends
The
The second
second important
important date
date isis
the
the date
date of
of record.
record. For
For Hiber
Hiber
Corporation
Corporation this
this would
would be
be
December
December 11.11.
Accounting for Cash Dividends
On
On this
this date,
date, ownership
ownership of of shares
shares
determines
determines who
who receives
receives the the
dividend.
dividend. NoNo entry
entry isis required.
required.
Accounting for Cash Dividends
The
The third
third important
important date
date isis the
the date
date
of
of payment.
payment. On On January
January 2,2, Hiber
Hiber
issues
issues dividend
dividend checks.
checks.
2
Accounting for Cash Dividends

Date
Date of
of Payment
Payment

Jan. 2 Cash Dividends Payable 42 500 00


Cash 42 500 00
Paid cash dividends.
Accounting for Stock Dividends
A
A distribution
distribution of
of dividends
dividends to to
stockholders
stockholders in in the
the form
form of
of the
the
firm’s
firm’s own
own shares
shares isis called
called aa
stock
stock dividend.
dividend.
Accounting for Stock Dividends
Stock
Stock dividends
dividends transfer
transfer pro
pro rata
rata shares
shares
of
of stock
stock to
to stockholders.
stockholders. Assume
Assume
Hendrix
Hendrix Corporation
Corporation issues
issues aa 5%
5% stock
stock
dividend
dividend on
on common
common stock,
stock, $20
$20 par,
par,
2,000,000
2,000,000 shares
shares issued.
issued.
Accounting for Stock Dividends
Hendrix Corporation, December 15 (before dividend)
Common Stock, $20 par $40,000,000
Paid-in Capital in Excess of Par--Common Stock 9,000,000
Retained Earnings 26,600,000

Dec. 15 Stock Dividends 3,100 000 00


Stock Dividends Distributable 2,000000 00
Paid-in Capital in Excess of
Par—Common Stock 1,100000 00
Declared stock dividend.
Accounting for Stock Dividends
On January 10, Hendix Corporation issues
the stock. This action increases the number
of shares outstanding by 100,000.

Jan. 10 Stock Dividends Distributable 2,000 000 00


Common Stock 2,000000 00
Issued stocks for the stock
dividend.
Accounting for Stock Dividends
Hendrix Corporation, December 15 (before dividend)
Common Stock, $20 par $40,000,000
Paid-in Capital in Excess of Par--Common Stock 9,000,000
Retained Earnings 26,600,000
$75,600,000

Hendrix Corporation, January 10 (after dividend)


Common Stock, $20 par $42,000,000
Paid-in Capital in Excess of Par--Common Stock 10,100,000
Retained Earnings 23,500,000
$75,600,000
Financial
Financial Analysis
Analysis and
and
Interpretation
Interpretation
Use:
Use: To
Dividend indicate
indicate the
ToYield
Dividend Yield therate
rate of
of return
return to
to common
common
stockholders
stockholders in
in terms
terms of
of dividends
dividends
2004 2003
Dividends per share of common $ 0.80 $ 0.60
Market price per share of common $20.50 $13.50

Dividends per Share of Common Stock


Dividend
DividendYield
Yield Market Price per Share of Common Stock
$.60
Dividend
DividendYield,
Yield,2006
$13.50 = 4.4%
2006

$.80
Dividend
DividendYield,
Yield,2007
2007 = 3.9%
$20.50
There
There are are two
two ways
ways to to report
report
stockholders’
stockholders’ equity equity inin the
the balance
balance
sheet.
sheet. In In Slide
Slide 58,
58, each
each class
class of
of
stock
stock isis listed
listed first,
first, followed
followed byby its
its
related
related paid-in
paid-in capital
capital accounts.
accounts.
61
Stockholders’ Equity
Paid-in capital:
Preferred 10% stock, $50 par,
cumulative (2,000 shares
authorized and issued) $100,000
Excess of issue price over par 10,000 $ 110,000
Common stock, $20 par
(50,000 shares authorized, 45,000
issued) $900,000
Excess of issue price over par 190,000 1,090,000
From sale of treasury stock 2,000
Total paid-in capital $1,202,000
Retained earnings 350,000
Total $1,552,000
Deduct treasury stock (600 shares at cost) 27,000
Total stockholders’ equity $1,525,000
Slide
Slide 6060 shows
shows the the second
second method.
method. Note Note
that
that the
the stock
stock accounts
accounts are
are listed
listed first.
first.
The
The other
other paid-in
paid-in capital
capital accounts
accounts are are
listed
listed as
as aa single
single item
item described
described as as
Additional
Additional paid-in
paid-in capital.
capital.
Stockholders’ Equity
Contributed capital:
Preferred 10% stock, cumulative
$50 par (2,000 shares authorized
and issued) $100,000
Common stock, $20 par
(50,000 shares authorized, 45,000
issued) 900,000
Additional paid-in capital 202,000
Total contributed capital $1,202,000
Retained earnings 350,000
Total $1,552,000
Deduct treasury stock (600 shares at cost) 27,000
Total stockholders’ equity $1,525,000
Chapter 12

The
The End
End

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