Accounting For Corporation
Accounting For Corporation
Contents
9.1 Aims
Aims and Objectives
9.2 Introduction
9.3 Definition of Corporation
9.4 Characteristics of Corporation
9.5 Advantages of Corporate form of Organization
9.6 Disadvantages of Corporate form of Organization
9.7 Formation of a Corporation
9.7.1 Organization Costs
9.7.2 Rights of Stockholders
9.7 Authorization and Issuance of Stocks
9.7.1 Types of Stocks / Shares
9.7.2 Issuance of Par-value Stocks
9.7.2.1 Authorization
9.7.2.2 Par-value Stock issued for cash
9.7.2.3 Par-value Stock issued on a subscription basis
9.7.2.4 Non cash issuance of Capital Stock
9.7.2.5 Issuance of No-par Stock
9.8 Accounting for Retained earnings and Dividends
9.8.1 Nature of Retained Earnings
9.8.2 Nature of Dividends
9.8.3 Relevant Dividends dates
9.8.4 Dividends and Characteristics of Preferred Stock
9.8.4.1 Participating and Non participating preferred stock
9.8.4.2 Cumulative and Non cumulative preferred stock
9.9 Accounting for Treasury Stocks
9.9.1 Reasons to acquired Treasury Stocks
9.9.2 Recording and Reporting Treasury Stock Transactions
9.10 Equity Per Share
9.11 Summary
9.12 Answers to Check Your Progress
9.13 Model Exam Questions
9.14 Glossary
This unit aims at discussing different issues related to a corporate form of organization such as
the characteristics of a corporation, accounting and reporting practical for the issuance of stocks.
Treasures stocks and equity per share. After studying this chapter, you will be able to:
- describe the characteristics, advantages and disadvantages of the corporate form of
business organization
- explain the rights of stockholders and the role of corporate directions.
- differentiate among authorized, issued and outstanding shares.
- Account for the issuance of capital stock
- understand the nature of retained earnings and dividends
- account for treasury stock transactions
- know how to calculate earnings per share.
9.1 INTRODUCTION
Assume that you are planning to start a new business. Would you choose a sole proprietorship, a
partnership or a corporation? In principles of accounting 1 and previous chapter of principles of
accounting you have studied about the first two forms of business organizations. In this chapter
the importance of corporate form of organization will be discussed.
A corporation is a legal entity having an existence separate and distinct from that of its owners.
In the eyes of the law there are two persons and a corporation is an ‘artificial person’ having
many of its own rights and responsibilities.
A corporate entity has many advantages not available in other forms of organization. Among the
advantages are the following:
a) Continuous existence: A corporation has perpetual existence in that its continuous existence
is not dissolved by the death on retirements of any of its members.
b) No personal liability for owners: Since a corporation is a separate legal entity, the creditors
of a corporation have a claim against the assets of the corporation, not the personal property
of the owners.
c) Greater regulation: since a corporation comes into existence according to the law of the
state, the law may provide for considerable regulation of the corporation’s activities. For
example, the withdrawal of funds from a corporation is subjects to certain limits sets by
law.
A corporation is created by obtaining a corporate charter. The charter is given from the states in
which the corporation is to be incorporated. To obtain a corporate charter an application called
articles of incorporation are prepared by t he organizers called incorporators and submitted to the
state corporations commissioner or other designated officials. These articles of incorporation
specify the purpose of the business, its location, the names of the organizers, the classes and
numbers of shares of capital stock authorized, and the consideration to be paid in by the
organizers for their respective shares. The article of incorporation is approved by the state and
charter is issued. Once a charter is obtained a board of directors is elected. The directors in turn
hold meetings at which officers of the corporation are appointed.
c) The rights to share in the distribution of assets upon liquid action: when a corporation
ends its existence, the creditors of the corporation must first be paid is full; any remaining
assets are dividend among stockholders in proportion to the number of shares owned.
d) Pre-emptive rights: the current stockholders has the right to purchase the shares of the
corporation on a prorate basis when new stocks are offered for sale. This preemptive
rights is designed to provide each stockholder the opportunity to maintain a proportional
ownership in the corporation.
2. Explain the meaning of the term double taxation at it applies to corporate profits.
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The state officials approve the articles of incorporation, which specify the number of shares a
corporation is authorized to issue. The total number of shares that may be issued is known as the
authorized shares.
shares. When the corporation receives cash is exchange for stock certificates, which
represents the number of shares issued, the shares become issued shares.
shares. Shares that are issued
and held by the stockholders are called outstanding shares.
shares. Sometimes a corporation requires
shares from its own shareholders. These shares are called treasury stocks,
stocks, which reduce the
number of outstanding shares.
A corporation may choose not to issue immediately all the authorized shares even though it is
customary to have a large number of authorized shares than presently needed. If more capital is
needed, the previously authorized shares will be readily available for issue. A corporation can
apply to the state for permission to increase the number of authorized shares.
Stocks according to their nature are classified into par value and no-par stocks.
stocks. Par value stocks
with a designated dollar amount per share as stated in the corporate charter and printed on the
stock certificates. On the other hand, some states allow corporations to issue stocks without
designating a par value. Such stocks are called no-par stocks.
stocks. When no par stocks are issued by a
corporation, the entire issuance price is viewed as a legal capital, which is subject to withdrawal.
Sometimes some states authorize the issuance of no-par stock with a stated, or assigned, value
per share that is established permanently by the corporate directors and is in the laws. Most
corporations use a stated value for no par stock.
For example, assume that 50,000 shares of Br. 2 par value common stock have seen authorized
and that 10,000 of these authorized shares are issued at a price of Br. 10 each. The entry would
be:
Cash………………………………………………………100.000
Common Stock…………………………………..20,000
Paid-in-capital is excess of par………………… 80,000
When stock is subscribed, the company debits stock subscription receivable for the subscription
price, credits capital stock subscribed for the par value of the subscribed shares, and credits paid
in capital in excess of the subscription price over par value. Later, as cash is collected, the entry
is a debit to cash and a credit to stock subscription receivable. When the entire subscription price
is collected, the stock certificates are issued for the subscribers. The issuance of stock is recorded
by debiting capital stock subscribed and crediting capital stock. The following illustration
demonstrates the accounting procedures for stock subscriptions.
Assume that 120,000 shares of RAM corporation common stock, par br. 10, are subscribed for at
Br. 12 by Misrak Binda. The total is payable in three installments. The following entries are
processed by RAM Corporation.
The corporation reported net income of Br. 150,000 for the third year and the BOD declared both
of the net income as dividend. If the preferred stock issued by the corporation is participating, the
preferred stockholders will receive. Br. 30,000 (Br. 20,000 + Br. 10,000), and the common
stockholders will receive Br. 60,000 (Br. 40,000 + Br. 20,000).
2. If a corporation has outstanding 1,000 shares of Br. 9 cumulative preferred stock of Br. 100
par and dividends have been passed for the preceding three years, what is their amount of
preferred dividends that must be declared is the current year before a dividend can be
declared on common stock?
a) Br. 9,000 c) Br. 36,000
b) Br. 27,000 d) None
Treasury stock is a corporation’s own stock (preferred or common) that has been issued and
required by the issuing corporation. A corporation may also accept shares of its own stock in
payment of a debits owed by a stockholder or as a donation from a stockholder.
Treasury stock does not reduce the number of shares issued, but does reduce the number of
outstanding shares. The purchase of treasury stock decreases both assets and stockholders’
equity. Moreover, treasury stock does not carry voting, dividend, preemptive, or liquidating
rights and is not assets.
To illustrate the cost method, assume that Harambe Corporation had 50,000 shares of Br. 10 par
common stock outstanding at the beginning of the current year. The company purchased 500
shares for cash and received 500 shares in settlement of a debt from stockholders. The markets
price of stocks was Br. 30/share. The following entry is required involving the transactions.
If the company sells 600 shares of the treasury stock for Br. 31 each, the entry would be:
Cash 18,600
Treasury stock 18,000
Paid in capital from sale of 600
Treasury stock
Paid in capital from sale of treasury stock is reported in the paid in capital section of the balance
sheet. Treasury stock is deducted from the total of the paid in capital and Retained earnings.
The amount appearing on the balance sheet as total stockholders’ equity can be stated in terms of
the equity per share. When there is only one class of stock, the equity per share is determined by
dividing total stockholders’ equity by the number of shares outstanding. For a corporation with
both preferred and common stock, it is necessary first to allocate the total equity between the two
classes. To illustrate, consider the following statements of stockholders’ equity at December 31,
19x1.
- 9 to preferred stock, Br. 50 par value, authorized 20,000 shares, issued and
Outstanding 12,000 share Br. 600,000
2. If the Retained Earnings account has a debit balance, how is it presented in the balance sheet
and what is it called?
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3. How is book value per share of common stock computed when a company has only one class
of stock?
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9.11 SUMMARY
Stockholders in a corporation normally have the rights to elect the board of directors, to share
in dividends declared by the directors, to share is the distribution of assets if the corporation
is liquidated, and to subscribe to additional shares if the corporation decides to increases the
number of shares outstanding.
Common stock represents the true residual ownership of a corporation. These share have
voting rights and cannot be called. Preferred stock has preference over common stock with
respects to dividends and to distributions in the events of liquidation.
When capital stock is issued, appropriate asset accounts are debited for the market price of
stock. A capital stock account is credited for the par value of the issued shares. The
difference between the market value received and the par value of the issued shares is
credited or debited to additional paid in capital accounts.
The stockholders; equity sections are classified into two: paid-in-capital and retained
earnings.
Any treasury stock held at the end of an accounting period is deducted from the total of the
paid-in-capital and retained earnings of the corporation.
To determine the equity per share, the equity allocated to each class is divided by the number
of shares outstanding of the respective class.
2. C
Jan. 7 Issued an additional 500 shares of common stock to Binda is exchange for his services in
organizing the corporation. The stockholders agreed that these services were worth Br.
11,000.
Jan12 Issued 2,500 shares of preferred stock for cash of Br. 250,000.
Jan. 4 acquired land as a building site in exchange for 15,000 shares of common stock. In view
of the appraised value of the land, the directors agreed that the common stock was to
valued for purpose of this transaction at Br. 15 per share.
Nov15 The first annual dividend of Br. 10 per share was declared on the preferred stock to be
Paid December 20.
Dec31 After the revenue and expenses were closed into the Income summary account, that
account indicated a net income of Br. 106,500.
Instructions
a) Prepare journal entries in general journal form to record the above transactions
b) Prepare stockholders’ equity section of the Mobile communications, Inc. balance sheets
at December 31.
2. Belay publications was organized early in 19x1 with authorization to issue 20,000 shares of
Br. 100 par value preferred stock and 1 million shares of Br. 1 par value common stock. All
of the preferred stock was issued at par, and 300,000 shares of common stock were sold for
Br. 20 per share. The preferred stock pays a 10% cumulative dividend and is callable at Br.
105. During the first five years of operations, the corporation earned a total of Br. 4,460,000
and paid dividends of Br. 1 per share each year on the common stock. In 19X6, however, the
corporation reported a net loss of Br. 1,600,000 and paid no dividends.
Instruction
Prepare the stockholders’ equity section of the balance sheet at December 31, 19X6.
9.14 GLOSSARY
Capital stock: Transferable units of ownership is a corporation. A broad term, which may
refer to common stock, preferred stock, or both.
Common stock: A type of capital stock, which possesses the basic rights of ownership including
the rights to vote.
Legal capital: Equal to the par value or stated value of capital stock issued. This amount
cannot be removed without special legal action.
Par value (or stated Value): the minimum amount per share to be invested is the corporation by
its own owners and cannot be withdrawn except by special legal
action.
Preferred stock: a class of capital stock usually having preferences as to dividends and in the
distribution of assets inevents of liquid action.
Subscriptions to Capital stock: formal promises to buy shares of stock from a corporation with
payment at a later date.