13-1

Accounting for
Chapter
Corporations

13
cGraw-Hill/Irwin1 © The McGraw-Hill Companies, Inc., 2006
 13-2

Learning objectives
 Identify characteristics of corporations and their organization.
 Describe the components of stockholders’ equity.
 Explain characteristics of common and preferred stock.
 Explain the form and content of a complete income
statement.
 Explain the items reported in retained earnings.
 Record the issuance of corporate stock.
 Distribute dividends between common stock and preferred
stock.
 Record transactions involving cash dividends.
 Account for stock dividends and stock splits.
 Record purchases and sales of treasury stock and the
retirement of stock.
cGraw-Hill/Irwin2 © The McGraw-Hill Companies, Inc., 2006
 13-3

Corporate Form of Organization

An entity
created by law.

Existence is Privately Held

Ownership
separate from
can be
owners.

Has rights and

privileges.
Publicly Held

cGraw-Hill/Irwin3 © The McGraw-Hill Companies, Inc., 2006

 13-4

Characteristics of Corporations
Advantages
 Separate Legal Entity
 Limited Liability of Stockholders
 Transferable Ownership Rights
 Continuous Life
 Stockholders Are Not Corporate Agents
 Ease of Capital Accumulation
Disadvantages
 Governmental Regulation
 Corporate Taxation
cGraw-Hill/Irwin4 © The McGraw-Hill Companies, Inc., 2006
 13-5

Organizing and Managing a Corporation

Stockholders

Board of Directors

President, Vice-President,
and Other Officers

Employees of the Corporation

cGraw-Hill/Irwin5 © The McGraw-Hill Companies, Inc., 2006

 13-6

Organizing and Managing a Corporation

C o r p o r a t e O r g a n iz a t io n C h a r t
Stockholders
Ultimate
S t o c k h o ld e r s usually meet
control.
once a year.
Selected by a
B o a r d o f D ir e c t o r s Overall
vote of the
responsibility
stockholders.
for managing
P r e s id e n t the company.

S e c re ta ry V ic e P r e s id e n t V ic e P r e s id e n t V ic e P r e s id e n t
F in a n c e P r o d u c t io n M a r k e t in g

cGraw-Hill/Irwin6 © The McGraw-Hill Companies, Inc., 2006

 13-7

Rights of Stockholders
Vote at stockholders’ meetings.
Sell stock.
 Purchase additional shares of stock.
Receive dividends, if any.
Share equally in any assets remaining
after creditors are paid in a liquidation.

cGraw-Hill/Irwin7 © The McGraw-Hill Companies, Inc., 2006

 13-8

Stock Certificates and Transfer

When the stock is sold, the stockholder signs a

transfer endorsement on the back of the stock
certificate.

Each unit of ownership is called a share of stock.

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

cGraw-Hill/Irwin8 © The McGraw-Hill Companies, Inc., 2006

 13-9

Basics of Capital Stock

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

cGraw-Hill/Irwin9 © The McGraw-Hill Companies, Inc., 2006

 13-10

Basics of Capital Stock

Total amount of stock that has been
issued to stockholders.

cGraw-Hill/Irwin10 © The McGraw-Hill Companies, Inc., 2006

 13-11

Selling (Issuing) Stock

≠
Par value is an
arbitrary amount Market price is the
assigned to each amount that each
share of stock when share of stock will
it is authorized. sell for in the market.
cGraw-Hill/Irwin11 © The McGraw-Hill Companies, Inc., 2006
 13-12

Issuing Par Value Stock

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.
Record:
• The cash received.
• The number of shares issued × the par value
per share in the Common Stock account.
• The remainder is assigned to Contributed
Capital in Excess of Par.
cGraw-Hill/Irwin12 © The McGraw-Hill Companies, Inc., 2006
 13-13

Issuing Par Value Stock

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.
Sept. 1 Cash 2,500,000
Common stock, $2 par value 200,000
Contributed capital in
excess of par value 2,300,000
Sold and issued 100,000 shares of common stock

cGraw-Hill/Irwin13 © The McGraw-Hill Companies, Inc., 2006

 13-14

Issuing Par Value Stock

cGraw-Hill/Irwin14 © The McGraw-Hill Companies, Inc., 2006

 13-15

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.
Record:
• The asset received at its market value.
• The number of shares issued × the par value
per share in the Common Stock account.
• The remainder is assigned to Contributed
Capital in Excess of Par.
cGraw-Hill/Irwin15 © The McGraw-Hill Companies, Inc., 2006
 13-16

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.
Sept. 1 Land 2,500,000
Common stock, $2 par value 200,000
Contributed capital in
excess of par value 2,300,000
Exchanges 100,000 common shares for land

cGraw-Hill/Irwin16 © The McGraw-Hill Companies, Inc., 2006

 13-17

Preferred Stock
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 Normally has no

dividend rate. voting rights.

cGraw-Hill/Irwin17 © The McGraw-Hill Companies, Inc., 2006

 13-18

Preferred Stock
 Dillon Snowboards issues 50 shares of $100
par value preferred stock for $6,000 cash on
July 1, 2005.
 Dr. Cash 6,000
Cr. Preferred Stock, $100 par value 5,000
Cr. Contributed Capital in Excess
of par value, preferred stock 1,000

cGraw-Hill/Irwin18 © The McGraw-Hill Companies, Inc., 2006

 13-19

Reasons for Issuing Preferred Stock

 To raise capital without sacrificing
control.
 To appeal to investors who may believe
the common stock is too risky or that
the expected return on common stock is
too low.

cGraw-Hill/Irwin19 © The McGraw-Hill Companies, Inc., 2006

 13-20

Cash Dividends

To pay a cash
dividend the Cash Dividend Types and Frequency
corporation must 100%
have: 80% 73%
2. A sufficient
60%
balance in retained
earnings and 40%
23%
3. The cash 20%
necessary to pay 0%
the dividend. Common Preferred

cGraw-Hill/Irwin20 © The McGraw-Hill Companies, Inc., 2006

 13-21

Cash Dividends
Regular cash dividends provide a return to
investors and almost always affect the
stock’s market value.

June
30

Stockholders
Corporation

Dividends
cGraw-Hill/Irwin21 © The McGraw-Hill Companies, Inc., 2006
 13-22

Entries for Cash Dividends

Three important dates

e n ds
D i vi d

Date of Declaration Date of Record Date of Payment

Record liability No entry Record payment of
for dividend. required. cash to stockholders.

cGraw-Hill/Irwin22 © The McGraw-Hill Companies, Inc., 2006

 13-23

Entries for 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
id e nds stockholders of record on February 19.
Div

Jan. 19 Retained earnings 10,000

Common dividend payable 10,000
Declared $1 per share cash dividend

Date of Declaration
Record liability
for dividend.
cGraw-Hill/Irwin23 © The McGraw-Hill Companies, Inc., 2006
 13-24

Entries for 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
Date of Record
February 19.
No entry
required.
cGraw-Hill/Irwin24 © The McGraw-Hill Companies, Inc., 2006
 13-25

Entries for 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.

Mar. 19 Common dividend payable 10,000

Cash 10,000
Paid $1 per share cash dividend

Date of Payment
Record payment of
cash to stockholders.
cGraw-Hill/Irwin25 © The McGraw-Hill Companies, Inc., 2006
 13-26

Deficits and Cash Dividends

Created when a company incurs cumulative losses
or pays dividends greater than total profits earned
in other years.

cGraw-Hill/Irwin26 © The McGraw-Hill Companies, Inc., 2006

 13-27

Stock Dividends
The corporation distributes additional shares of
its own stock to its stockholders without
receiving any payment in return.

Why a stock dividend?

100shares
100 Shares
HotAir, Inc. •Can be used to keep the market
Common Stock price on the stock affordable.
$1 par
$1 par value
•Can provide evidence of
management’s confidence that
Stockholders
the company is doing well.

cGraw-Hill/Irwin27 © The McGraw-Hill Companies, Inc., 2006

 13-28

Stock Dividends
 A company has 1,000 common shares
outstanding. Market price is $12. The company
announces a 20% stock dividend. The market
price will be $10. However, due to the
expectation of future more cash dividend, the
market price may increase to 10.5 or so.

cGraw-Hill/Irwin28 © The McGraw-Hill Companies, Inc., 2006

 13-29

Stock Dividends
Small Stock Dividend
Distribution is ≤ 25% of the previously
outstanding shares.
Capitalize retained earnings for the market
value of the shares to be distributed.

Large Stock Dividend

Distribution is > 25% of the previously
outstanding shares.
Capitalize retained earnings for the minimum
amount required by state law, usually par or
stated value of the shares.
cGraw-Hill/Irwin29 © The McGraw-Hill Companies, Inc., 2006
 13-30

Recording a Small Stock Dividend

Here is the stockholders’ equity section
of Quest’s balance sheet prior to the
declaration of a small stock dividend.

cGraw-Hill/Irwin30 © The McGraw-Hill Companies, Inc., 2006

 13-31

Recording a Small Stock Dividend

On December 31, 2005, 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, 2006. Let’s make
the December 31 entry.
Dec. 31 Retained earnings 20,000
Common stock dividend
distributable 2,000
Contributed capital in
excess of par value 18,000
Declared a 2,000 shares (2%) stock dividend
100,000 × 2% = 2,000 × $10 = $20,000/ 10000*.02=2000shares
2,000 × $1 par = $2,000/2000*$10=20000RE, 2000*$1=2000
cGraw-Hill/Irwin31 © The McGraw-Hill Companies, Inc., 2006
 13-32

Before the
stock
dividend.

After the
stock
dividend.

cGraw-Hill/Irwin32 © The McGraw-Hill Companies, Inc., 2006

 13-33

Recording a Large Stock Dividend

Router, Inc. shows the following
stockholders’ equity section just prior to
issuing a large stock dividend.

cGraw-Hill/Irwin33 © The McGraw-Hill Companies, Inc., 2006

 13-34

Recording a Large Stock Dividend

On December 31, 2005, Router declared a 40%
stock dividend, when the stock was selling
for $8 per share. State law requires that
large stock dividends be capitalized at par
value per share.
Dec. 31 Retained earnings 20,000
Common stock dividend
distributable 20,000
Declared a 20,000 shares (40%) stock dividend

50,000 × 40% = 20,000 shares × $1 par value = $20,000

cGraw-Hill/Irwin34 © The McGraw-Hill Companies, Inc., 2006
 13-35

Stock Splits
A distribution of additional shares of stock to
stockholders according to their percent
ownership.
$10 par value

Common Stock Old

Shares
100 shares

$5 par value
New
Shares Common Stock
200 shares
cGraw-Hill/Irwin35 © The McGraw-Hill Companies, Inc., 2006
 13-36

Stock Splits
Thomas, Inc. has the following stockholders’
equity section just prior to a 2-for-1 stock split.

cGraw-Hill/Irwin36 © The McGraw-Hill Companies, Inc., 2006

 13-37

Stock Splits
After the 2-for-1 split the stockholders’ equity section
of the balance sheet looks like this . . .

No accounting
entry is made.

cGraw-Hill/Irwin37 © The McGraw-Hill Companies, Inc., 2006

 13-38

Stock Splits
 The split does not affect any equity amounts
reported on balance sheet or any individual
stockholder’s percent ownership. Both the
contributed capital and retained earnings
accounts are unchanged by a split.

cGraw-Hill/Irwin38 © The McGraw-Hill Companies, Inc., 2006

 13-39

Treasury Stock
Corporations acquire shares of their own
stock.
Use the shares to acquire
Why would a
control of another corporation.
company do
that?
To avoid a hostile takeover.

Use the shares for

employee stock options.
To maintain a strong market for
its stock or show management
confidence in the current price.
cGraw-Hill/Irwin39 © The McGraw-Hill Companies, Inc., 2006
 13-40

Treasury Stock

cGraw-Hill/Irwin40 © The McGraw-Hill Companies, Inc., 2006

 13-41

Purchasing Treasury Stock

On May 8, Whitt, Inc. purchased 2,000 of its
own shares of stock in the open market for
$8,000.

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.

cGraw-Hill/Irwin41 © The McGraw-Hill Companies, Inc., 2006

 13-42

Selling Treasury Stock at Cost

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

June 30 Cash 400

Treasury stock, common 400
Sold 100 shares of treasury for $4 per share

$8,000 ÷ 2,000 shares = $4 cost per treasury share

cGraw-Hill/Irwin42 © The McGraw-Hill Companies, Inc., 2006

 13-43

Selling Treasury Stock Above Cost

On July 19, Whitt, Inc. sold an additional 500
shares of its treasury stock for $8 per
share.
July 19 Cash 4,000
Treasury stock, 2,000
Contributed capital,
treasury stock 2,000
Sold 500 treasury shares for $8 per share

cGraw-Hill/Irwin43 © The McGraw-Hill Companies, Inc., 2006

 13-44

Selling Treasury Stock Below Cost

On August 27, Whitt sold an additional 400
shares of its treasury stock for $1.50 per
share.
Aug. 27 Cash 600
Contributed capital,
treasury stock 1,000
Treasury stock, 1,600
Sold 500 treasury shares for $1.50 per share

cGraw-Hill/Irwin44 © The McGraw-Hill Companies, Inc., 2006

 13-45

Reporting Income and Equity

Extraordinary
Items
Changes in
Discontinued Accounting
Segments Principle

Continuing
Operations Net Income
cGraw-Hill/Irwin45 © The McGraw-Hill Companies, Inc., 2006
 13-46

Continuing Operations

Revenues, expenses
and income generated
by the company’s
continuing operations.

Continuing
Operations Net Income
cGraw-Hill/Irwin46 © The McGraw-Hill Companies, Inc., 2006
 13-47

Discontinued Segments
Income from operating the discontinued segment prior
to its disposal and gain or loss on the sale of the net
assets of the segment.
Discontinued
Segments

Net Income
cGraw-Hill/Irwin47 © The McGraw-Hill Companies, Inc., 2006
 13-48

Extraordinary Items

Extraordinary
Items

A gain or loss that

is unusual in nature
and infrequent in
occurrence.
Net Income
cGraw-Hill/Irwin48 © The McGraw-Hill Companies, Inc., 2006
 13-49

Changes in Accounting Principles

The increase or
decrease in income Changes in
when changing from Accounting
one generally accepted Principle
accounting principle to
another.

Net Income
cGraw-Hill/Irwin49 © The McGraw-Hill Companies, Inc., 2006
 13-50

Income Statement

cGraw-Hill/Irwin50 © The McGraw-Hill Companies, Inc., 2006

 13-51

Earnings Per Share

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

cGraw-Hill/Irwin51 © The McGraw-Hill Companies, Inc., 2006

 13-52

Changes in Shares Outstanding

Derby, Inc. reports net income of $75,000 and
paid preferred dividends of $10,000 during
2005. The company started the year with
10,000 shares of common stock outstanding.
Derby sold an additional 4,000 share of stock
on March 31, and purchased 2,000 treasury
shares on September 30, 2005.

cGraw-Hill/Irwin52 © The McGraw-Hill Companies, Inc., 2006

 13-53

Changes in Shares Outstanding

Derby, Inc. reports net income of $75,000 and
paid preferred dividends of $10,000 during
2005. The company started the year with
10,000 shares of common stock outstanding.
Derby sold an additional 4,000 share of stock
on March 31, and purchased 2,000 treasury
shares on September 30, 2005.

$75,000 - $10,000
EPS = = $5.20
12,500

cGraw-Hill/Irwin53 © The McGraw-Hill Companies, Inc., 2006

 13-54

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
price of
Option stock $75
purchase per share.
price $30
per share.
cGraw-Hill/Irwin54 © The McGraw-Hill Companies, Inc., 2006
 13-55

Stock Options
Options are given to key employees to
motivate them to:
 focus on company performance,
 take a long-run perspective, and
 remain with the company.

cGraw-Hill/Irwin55 © The McGraw-Hill Companies, Inc., 2006

 13-56

cGraw-Hill/Irwin56 © The McGraw-Hill Companies, Inc., 2006

 13-57

Statement of Retained Earnings

Total cumulative amount of reported net income
less any net losses and dividends declared
since the company started operating.

cGraw-Hill/Irwin57 © The McGraw-Hill Companies, Inc., 2006

 13-58

Restricted Retained Earnings

Legal Contractual
Loan agreements
Most states restrict
can include
the amount of
restrictions on
treasury stock
paying
purchases to the
dividends below a
amount of retained
certain amount of
earnings.
retained earnings.

cGraw-Hill/Irwin58 © The McGraw-Hill Companies, Inc., 2006

 13-59

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.

cGraw-Hill/Irwin59 © The McGraw-Hill Companies, Inc., 2006

 13-60

Prior Period Adjustments

Correction of material errors in past years’
financial statements. If an amount is incorrectly
expensed, add amount to Retained Earnings.

cGraw-Hill/Irwin60 © The McGraw-Hill Companies, Inc., 2006

 13-61

Statement of Stockholders’ Equity

Matrix, Inc.
Statement of Stockholders' Equity
For the Year Ended December 31, 2005

Common stock and

(In millions) capital in excess of par Retained
Shares Amount Earnings Total
Balance at January 1, 2005 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, 2005 821 $ 2,740 $ 13,595 $ 16,335

This is a more inclusive statement than the statement of

retained earnings.
cGraw-Hill/Irwin61 © The McGraw-Hill Companies, Inc., 2006
 13-62

Book Value per Share—Common

Records 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

cGraw-Hill/Irwin62 © The McGraw-Hill Companies, Inc., 2006

 13-63

Book Value per Share—Preferred

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

cGraw-Hill/Irwin63 © The McGraw-Hill Companies, Inc., 2006

 13-64

Dividend Yield
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

cGraw-Hill/Irwin64 © The McGraw-Hill Companies, Inc., 2006

 13-65

Price Earnings
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

If earnings go up,
will the market price
of my stock follow?

cGraw-Hill/Irwin65 © The McGraw-Hill Companies, Inc., 2006

 13-66

Homework for Chapter 13

 Ex 13-16, 13-17
 Problem 13-2A, 13-4A
 Due on July 12, 2006 (Wednesday)

cGraw-Hill/Irwin66 © The McGraw-Hill Companies, Inc., 2006

 13-67

End of Chapter 13

cGraw-Hill/Irwin67 © The McGraw-Hill Companies, Inc., 2006