Chapter 19

1. Chapter 19 Corporate Accounting: Formation and Paid-In Capital

2. Corporation • Definition: • A form of business that is owned by investors (called stockholders or shareholders). • Their investments are referred to as the stock or capital stock of the corporation. Chapter 19

3. Corporations • Some are publicly held. Their stock is owned by many investors and usually traded on an organized stock exchange. • Others are closely held. They may have as few as three stockholders. Often, these corporations are controlled by a family. • Most of the very large businesses in the U.S., such as General Motors, IBM, Coca-Cola, are publicly held corporations. Chapter 19

4. Legal Status of Corporations • Unlike a sole proprietorship or a partnership, a corporation is created by law as an entity separate from its owners. • A corporation can make binding contracts, sue and be sued, own property, hire and fire employees, and incur debts. • Because of its separate legal existence it has most of the legal rights and responsibilities of an individual. Chapter 19

5. Advantages of Corporations • Have limited liability. The stockholders are not personally responsible for the debts of the business. • Have a greater ability to raise capital. By selling stock, corporations can obtain large amounts of money to fund growth. Chapter 19

6. Advantages of Corporations • Have a continuous life. The life of a corporation is not affected by the death, incapacity, or withdrawal of individual stockholders. • Ownership can easily be transferred. Ownership is represented by shares of stock, which can be sold by one stockholder to another. Chapter 19

7. Advantages of Corporations • There is no mutual agency. Unless stockholders are officers of the corporation, they cannot enter into contracts for the firm. • More likely to have professional management. Publicly held corporations have the resources to hire managers who may have skills and experience that stockholders lack. Chapter 19

8. Disadvantages ofCorporations • More heavily taxed. They are required to pay federal and state income taxes. Also, when they distribute part of their earnings to stockholders, the stockholders must pay personal income taxes on these amounts. • More heavily regulated. They are subject to many state and federal laws and must file many reports with government agencies, especially if they are publicly held. Chapter 19

9. Forming a Corporation • The formation of corporations is regulated by the states. • Any group that wishes to form a corporation must submit an application to the proper agency in its state. • If the state approves the application, it issues a corporate charter or certificate of incorporation. Chapter 19

10. Forming a Corporation • After the incorporators receive the corporate charter, they agree on a set of bylaws to govern the firm. • The incorporators then hold a meeting of stockholders and elect a board of directors. Chapter 19

11. Forming a Corporation • The board of directors appoints officers to manage the corporation. • The officers hire employees, rent facilities, and take any other actions necessary to start the business. Chapter 19

12. Organization Costs • The costs of forming a corporation include: • lawyers’ fees • fee paid for the state charter • cost of printing stock certificates • cost of promoting the stock Chapter 19

13. Organization Costs • These costs are debited to an intangible asset account called Organization Costs. • The balance of Organization Costs is amortized (written off) over a period of time, which must not exceed 40 years. Chapter 19

14. Corporate Capital • The owner’s equity of a corporation is called stockholders’ equity. • Stockholders’ equity is divided into paid-in capital and earned capital. • Paid-in capital comes from the shares of stock the corporation sells to investors. Chapter 19

15. Corporate Capital • Earned capital comes from the earnings of the corporation. Earnings that have accumulated and not been paid out to stockholders are called retained earnings. • The Capital Stock account is used to record the amounts received from selling stock to investors. Chapter 19

16. Corporate Capital • The Retained Earnings account is used to record the earnings of the corporation in past periods that have not been distributed to stockholders. • Both of these accounts are stockholders’ equity accounts that increase on the credit side and decrease on the debit side. Chapter 19

17. Capital Stock • Definition: • General term used to describe the shares of ownership in a corporation. • Corporations issue stock certificates to investors as evidence of their shares of ownership. Chapter 19

18. Capital Stock • The charter of a corporation specifies the maximum number of shares it can issue. This number of shares is the authorized stock. • The shares that have been sold to investors are known as the issued stock. Chapter 19

19. Capital Stock • A corporation may buy back some of the stock it previously issued. These shares are called treasury stock. • Outstanding stock is the difference between the number of shares issued and the number of treasury shares held by the corporation. Chapter 19

20. Capital Stock • There are two basic types of stock. • Common Stock • Preferred Stock • If a corporation issues only one type of capital stock, it is common stock. Chapter 19

21. Common Stock • Owners of common stock usually have the following rights. • Right to receive dividends when they are declared by the board of directors. • Right to vote for the board of directors and on certain important corporate issues. Chapter 19

22. Common Stock • Right to maintain their proportionate share of the corporation if additional stock is issued. • Right to share in the final distribution of assets if the corporation is liquidated. Chapter 19

23. Preferred Stock • Owners of preferred stock have special rights not available to owners of common stock. • Have a prior claim to any dividends declared by the board of directors. • Have a prior claim to the assets of the corporation in case of a liquidation. Chapter 19

24. Preferred Stock • Usually has a stated dividend rate and a stated liquidation value. • May be cumulative or noncumulative. • With cumulative preferred stock, unpaid dividends accumulate and must be paid before the owners of the common stock receive any dividends. Chapter 19

25. Preferred Stock • May be participating or nonparticipating. • Owners of participating preferred stock are entitled to their stated dividend if the board of directors makes funds available. Chapter 19

26. Issuing Capital Stock with a Par Value • For legal purposes, some shares of stock are issued with a par value, such as $1 or $10 per share. • Par value has nothing to do with the market value. Chapter 19

27. Issuing Capital Stock with a Par Value • The par value of all shares outstanding is the legal capital of the corporation. • In most states, a corporation must have resources equal to its legal capital before it pays dividends. Chapter 19

28. Issuing Capital with No Par Value • Some states allow corporations to issue stock without a par value. • If there is no par value, the legal capital of the corporation is the amount received from all shares issued. Chapter 19

29. Issuing Capital with No Par Value • Some states that permit the sale of no-par value stock require corporations assign a stated value. • Market value of a share of stock is the actual price at which it can be sold. Chapter 19

30. Recording Stock Issued at Par Value for Cash • On January 2, 20X1, the Hill Corporation issued 1,000 shares of $100 par value preferred stock at par and 40,000 shares of $10 par value common stock at par. Chapter 19

31. Recording Stock Issued at Par Value for Cash • 20X1 • Jan. 2 Cash 500,000 • Preferred Stock 100,000 • Common Stock 400,000 • Issued 1,000 shares of • preferred stock and • 40,000 shares of common • stock at par for cash. Chapter 19

32. Recording Stock Issued at Par Value for Noncash Assets • The Hill Corporation issued 900 shares of $10 par value common stock at par to a lawyer who helped to organize the firm. • The total par value of the shares issued ($9,000) is debited to the intangible asset account Organization Costs and credited to the Common Stock account. Chapter 19

33. Recording Stock Issued at Par Value for Noncash Assets • 20X1 • Jan. 5 Organization Costs 9,000 • Common Stock 9,000 • Issued 900 shares of • common stock at par • for legal services received • during incorporation. Chapter 19

34. Issuing Stock Above Par Value • After a corporation has operated successfully for a while, it may be able to sell its stock above par value. • When the market value of stock exceeds the par value, the stock sells at a premium. Chapter 19

35. Issuing Stock Above Par Value • Example: • On March 1, 20X2, the Hill Corporation issued 500 shares of $100 par value preferred stock at $104 and 20,000 shares of $10 par value common stock at $14. Chapter 19

36. Recording Stock Issued at a Premium • When preferred stock is issued at a premium, the par value is credited to the Preferred Stock account. • The premium is credited to a separate stockholders’ equity account called Paid-In Capital in Excess of Par—Preferred. • The same procedure is followed for the common stock. Separate accounts are used to record the par value and the premium. Chapter 19

37. Recording Stock Issued at a Premium • 20X2 • Mar. 1 Cash 332,000 • Preferred Stock 50,000 • Paid-In Capital in Excess of Par—Preferred 2,000 • Common Stock 200,000 • Paid-In Capital in Excess • of Par—Common 80,000 • Issued 500 shares of $100 • par value preferred stock at • $104 and 20,000 shares of • $10 par value common stock at $14. Chapter 19

38. Issuing Stock Below Par Value • When a stock sells below its par value, it is said to sell at a discount. • In most states, it is illegal to issue stock at a discount. • Assume the state where the Briggs Corporation is located allows the issuance of stock at a discount. Chapter 19

39. Issuing Stock Below Par Value • 20X1 • Aug. 10 Cash 70,000 • Discount on Common 30,000 • Stock • Common Stock 100,000 • Issued 10,000 shares • of $10 par value common • stock at $7. Chapter 19

40. Issuing No-par Value Stock for Cash • On August 1, 20X1, the Davis Corporation issued 25,000 shares of its no-par value common stock for $20 a share. • The total amount received ($500,000) is credited to the Common Stock account. Chapter 19

41. Issuing No-par Value Stock for Cash • 20X1 • Aug. 1 Cash 500,000 • Common Stock 500,000 • Issued 25,000 shares • of no-par value stock • at $20. Chapter 19

42. Issuing Stated Value Stock for Cash • When stock with a stated value is issued, the journal entry is similar to that for a par value stock. • Example: • The Lang Corporation issued 5,000 shares of its $10 stated value stock at $12. Chapter 19

43. Issuing Stated Value Stock for Cash • 20X3 • Feb. 15 Cash 60,000 • Common Stock 50,000 • Paid-In Cap. in Excess • of Stated Val.—Com. 10,000 • Issued 5,000 shares of • $10 stated value common • stock at $12. Chapter 19

44. Stock Subscriptions • Sometimes corporations issue stock on a subscription basis—on the installment plan. • The subscribers make several payments and then receive their stock certificates. Chapter 19

45. Stock Subscriptions • Example: • On August 1, 20X2, the Hill Corporation accepted subscriptions for 10,000 shares of its $10 par value common stock at $15. The subscribers will make three equal payments. Chapter 19

46. Recording a Stock Subscription • The total amount to be received from a stock subscription is debited to an asset account called Subscriptions Receivable. • When a subscription involves common stock, the par value is credited to a stockholders’ equity account called Common Stock Subscribed. Chapter 19

47. Recording a Stock Subscription • If there is a premium, it is credited to Paid-In Capital in Excess of Par—Common. • The following entry is made at the Hill Corporation when it accepts subscriptions for common stock. Chapter 19

48. Recording a Stock Subscription • 20X2 • Aug. 1 Subscriptions Receivable 150,000 • Common Stock Subscribed 100,000 • Paid-In Cap. in Excess of Par—Common 50,000 Accepted subscriptions for • 10,000 shares of $10 par • value common stock at $15. Chapter 19

49. Recording the Collection of Stock Subscriptions • On October 1, 20X2, the Hill Corporation received the third installment for the stock subscriptions and issued the stock certificates to the subscribers. Chapter 19

50. Recording the Collection of Stock Subscriptions • 20X2 • Oct. 1 Cash 50,000 • Subscriptions Receivable 50,000 • Collected final installment • of subscriptions of • August 1. • 1 Common Stock Subscribed 100,000 • Common Stock 100,000 • Issued certificates to • subscribers of August 1. Chapter 19