Corporations: Organization, Capital Stock Transactions, and Dividends

1. Corporations: Organization, Capital Stock Transactions, and Dividends Instructor’s Lecture P.H.

2. Characteristics of a Corporation • a legal entity, separate from its owners (stockholders) • limited liability • a stockholder’s loss is limited to his/her investment • subject to double taxation • the corporation pays taxes on earnings • the stockholder pays taxes on dividends received

3. Organizational Structure of a Corporation Stockholders elect Board of Directors selects Officers hire Employees

4. Owner’s Equity in a Corporation • is called Stockholders’ Equity, Shareholders’ Equity, Shareholders’Investment, or Capital • consists of two main sources: • paid-in capital (also called contributed capital) • retained earnings

5. Stockholders’ Equity: • Paid-in capital is capital contributed to the corporation by the stockholders • Retained earningsisnet incomeearned by the corporation and retained (kept) in the business (not distributed to the stockholders in the form of dividends)

6. Stockholders’ Equity: Paid-in Capital • Paid-in capital is recorded in separate accounts for each class of stock, for example, common stock and preferred stock • If there is only one class of stock, it is called Common Stock, or Capital Stock

7. Stockholders’ Equity: Retained Earnings • Net income or net loss is closed to the Retained Earnings account at the end of the period • The Dividends account (similar to the Drawing account) is also closed the Retained Earnings account

8. Stockholders’ Equity: Retained Earnings • Retained earnings is accumulated net income • net income increases retained earnings • dividends decrease retained earnings

9. Stockholders’ Equity: Retained Earnings • Retained earnings may also be called earnings retained for use in the business, or earnings reinvested in the business • The normal balance of the Retained Earnings account is credit (remember, it is an owners’ equity account) • A debit balance in the Retained Earnings account is called a deficit, and is the result of accumulated net losses

10. Stockholders’ Equity: Retained Earnings • A deficit is deducted from paid-in capital to determine total stockholders’ equity • Just as net income does not represent cash available, retained earnings does not represent surplus cash

11. Stockholders’ Equity: Sources of Paid-In Capital • Stock • Donations of real estate or other assets

12. Stockholders’ Equity: Sources of Paid-In Capital Stock • Authorized • stated in the charter of the corporation • Issued • shares issued (sold) to the stockholders • Outstanding • stock remaining in the hands of the stockholders • shares that receive dividends

13. Stockholders’ Equity: Sources of Paid-In Capital Classes of Stock • Common Stock • when there is only one class of stock it is “common stock” • Preferred Stock • nonparticipating vs. participating • most preferred stock is nonparticipating • cumulative vs. non-cumulative • cumulative preferred stock has the right to receive regular dividends that have been passed (are in arrears) before any common stock dividends are paid

14. Stockholders’ Equity: Sources of Paid-In Capital Preferred Stock • Has preference over common stockholders in receiving dividends • Has preference over common stockholders in receiving assets on liquidation

15. Stockholders’ Equity: Sources of Paid-In CapitalRights of Stockholders • The right to vote • The right to share in distributions of earnings (dividends) • The right to share in assets on liquidation (the winding up of a corporation when it goes out of business)

16. Stockholders’ Equity: Sources of Paid-In CapitalTerms • Par Value • a monetary amount that may be assigned to a share of stock • related to legal capital (a minimum amount of stockholder contribution that a corporation may be required to retain for the protection of its creditors) • Stated Value • some states may require a corporation to assign a stated value to no-par stock

17. Stockholders’ Equity: Sources of Paid-In CapitalIssuing (Selling) Stock at Par

18. Stockholders’ Equity: Sources of Paid-In CapitalIssuing (Selling) Stock at a Premium *When stock is issued at a price that is above par, a separate account is credited for the amount abovepar

19. Stockholders’ Equity: Sources of Paid-In CapitalIssuing (Selling) Stock With a Stated Value at a Premium *When no-par stock that has been assigned a stated value is issued at a price that is above par, a separate account is credited for the amount abovepar

20. Stockholders’ Equity Treasury Stock • Treasury stock is shares of its own stock that a corporation has once issued and then reacquires • The number of shares issued and the number of shares outstanding will be different if the corporation holds treasury stock • Shares held in the treasury do not receive dividends • Treasury stock reduces total stockholder’s equity

21. Stockholders’ EquityReasons for PurchasingTreasury Stock • For resale to employees • To reissue as a bonus to employees • To support (boost) the market price of the stock

22. Stockholders’ EquityTreasury Stock • Follow the transactions and corresponding journal entries for treasury stock in your text • Use T-accounts to post to the Treasury Stock and Paid-In Capital from Sale of Treasury Stock accounts, and keep track of the number of shares of treasury stock as you do your homework

23. Stock Splits • A reduction in the par or stated value of a share of common stock, and the issuance of a proportionate number of additional shares • Applies to all shares, including unissued, issued, and treasury shares

24. Stock Splits • A stock split does not change the total dollar amount of common stock outstanding; only the par value per share and the number of shares is changed • A stock split does not require a journal entry—the details are disclosed in the notes to the financial statements • A stock split does not change the proportional ownership in the corporation for an individual stockholder

25. Stock SplitsIllustrated Assume that a corporation has 10,000 shares of $100 par value common stock outstanding with a market price of $120 per share. The board of directors declares a 4-for-1 stock split. What is the new par value per share, the new total number of shares outstanding, and the the total dollar amount of common stock outstanding after the split?

26. Stock SplitsIllustrated

27. Stock SplitsIllustrated The proportional ownership in the corporation does not change for an individual stockholder. Let’s say a stockholder has 100 shares before the split: % ownership before the split: % ownership after the split: 100 shares/10,000 shares= 10% 400 shares/ 40,000 shares =10%

28. Stock SplitsIllustrated What would you expect the market price per share to change to?

29. Stock SplitsIllustrated Did you get $30?* *$120/4

30. Accounting for DividendsConditions for a Cash Dividend • Sufficient retained earnings • declaration of a dividend reduces retained earnings • Sufficient cash • Formal action by the board of directors

31. Accounting for DividendsImportant Dates • Date of declaration • Date of record • determines who gets the dividend • Date of payment Journal entries are required for the date of declaration and the date of payment

32. Accounting for DividendsCash Dividends

33. Accounting for DividendsStock Dividends Assume the following information for a corporation: Common Stock, $10 par (200,000 shares issued) On Dec. 15, the board of directors declares a stock dividend of 2% (4,000 shares) to be issued on Jan. 10 to stockholders of record on Dec. 31. The market price of the stock on Dec. 15 is $15 a share.

34. Accounting for DividendsStock Dividends *4,000 shares x $15/share (market price per share on Dec. 15) **4,000 shares x 10 share (par value)

35. Accounting for DividendsStock Dividends • A stock dividend does not change the assets, liabilities, or total stockholders’ equity of the corporation. It also does not change the proportional ownership in the corporation for an individual stockholder.

36. Financial Analysis and InterpretationDividend Yield Indicates the rate of return to stockholders in terms of cash dividend distributions: Dividends per share of Common Stock Market Price per share of Common Stock Dividend Yield The dividend yield is of special interest to stockholders whose main objective is to receive a current cash return on their investment

37. Chapter 12: New Accounts