Chapter 13: Corporations:Organization andCapital Stock Transactions

Question 1

Capital stock

Answer 1

An individual’s ownership of the corporation’s capital. Issued as stock certificates

Question 2

Outstanding stock

Answer 2

Issued stock in the hands of stockholders

Question 3

Par Value

Answer 3

An amount assigned by a company to the share of it’s stock. Generally lower than expecting to sell at to avoid selling under par value

Question 4

Underwriter

Answer 4

A firm that handles the issuance of a company’s stock to the public, usually assuming some of the risk by agreeing to buy the stock if the firm cannot sell all of the stock to it’s clients

Question 5

Issue price

Answer 5

Amount the corporation receives from issuing stock (usually exceeds par value)

Question 6

Premium

Answer 6

Amount above par at which a stock is issued

Question 7

Reasons companies purchase treasury wtock

Answer 7

1) to increase net assets by buying low and selling high
2) to support the company’s stock price
3) to avoid a takeover by an outside party (by reducing the number of outstanding shares that have voting rights)
4) to reward employees with stock

Question 8

Preferred Stock

Answer 8

Has contractual claims that give it priority over common stock:

• Preference as to dividends
• Preference as to assets in case of Liquidations
• Often Non-Voting

May have par value or non par-value

Often has designated annual dividend, stated as % of par value

Journaling is similar to common stock

Question 9

Reasons for Treasury Stock

Answer 9

• to reissue shares to officer or employees (compensation)
• To enhance stock market value
• To have shares to use in acquisition of other companies
• To increase earnings per share
• To rid company of disgruntled investors
• To avoid a takeover

May indicate to investors that the company is not optimistic about growth (otherwise they would use the money to fund expansion)

Question 10

Legal Capital

Answer 10

the portion of stockholders’ equity that cannot be used for dividends. (Not intended to protect stockholders.)

Question 11

Stock Split

Answer 11

Increasing the number of shares and lowing the price so the overall value stays the same

Question 12

Treasury Stock

Answer 12

Corporation owns the stock it has re-acquired from shareholders, but not retired.

• A contra-stockholders’ equity account
  
  • Has a Debit Normal Balance
  • NOT an asset
  • Reduces stockholders’ equity
  • No voting or dividend rights

(buy back of outstanding stock is the creation of treasury stock)

Question 13

Preferred stock Dividend preferences

Answer 13

Per share dividend amount stated as percentage of preferred stock par value (or specified amount)

If not stated to be non-cumulative assumed to have cumulative dividends - holders of preferred stock must be paid annual dividends PLUS any dividends in arrears before common stockholders receive dividends

Question 14

dividends in Arrears

Answer 14

Dividends not declared in a period. Not a liability. Disclosed in financial statement notes.

Question 15

APIC

Answer 15

Paid-in capital in excess of par (or stated) value

AKA: Additional Paid-In Capital
AKA: Premium on stock

Question 16

Sources of Owner’s Equity

Answer 16

Owner’s Equity = Corporate Capital

1) Money invested by Owners/ Stockholders:
- Paid in capital (common vs Preferred stock)
2) Money made by the corporation
- Retained Earnings

Question 17

Retained Earnings

Answer 17

Net income a corporation retains for future use

Earned but not property of/ distributable to the owners

Question 18

Stated Value of Shares

Answer 18

Board can assign a stated value to no-par value stock (= legal capital) in “many states”

If no stated value per GAAP all issuance proceeds = legal capital

Question 19

Corporation

Answer 19

An entity separate and distinct from it’s owners

• for profit and not-for-profit
• publicly held vs. privately held (aka closely held)
• limited liability to stockholders (only investment amount can be lost)
• continuous life
• Transferable ownership rights (can acquire capital via issuing stock)
• Separate taxes
• Separation of ownership and management

Question 20

Par Value Stock

Answer 20

Value per share assigned by corporate charter

used to equal legal capital per share that a company must retain to protect creditors, but that’s no longer required in most states

Question 21

Issuance IPO and Market Price

Answer 21

• Can issue directly or through an investment firm

IPO price set using:

• anticipated earnings
• expected dividend rate per share
• current financial position and the economy
• state of security market

Market value = price on stock exchange

interaction between buyer and seller determines price, may be beyond company control

Question 22

Authorized Shares

Answer 22

Amount of stock corporation is authorized to sell indicated in the charter.
- often reported in the Stockholders’ Equity section of reports

Issued = shares actually printed
Outstanding shares = issued shares less treasury stock

Unissued shares = additional shares to issue without amending the charter

Question 23

Stockholder’s rights

Answer 23

1) Vote on actions requiring stockholder approval (such as board elections)
2) Share corporate earnings via receipt of dividends
3) Keep same percentage of ownership when new shares are issued (pre-emptive right)
4) Share in assets upon liquidation in proportion to their holdings (residual claim. Paid after liabilities)

Stockholders CANNOT bind the business in a contract (separation of owners and management)

Question 24

Setting up a corporation

Answer 24

• File with secretary of state (pay incorporation fee)
• State grants charter (articles of incorporation)
• Corporation develops by-laws
• if engaged in interstate commerce must obtain license from each state

Question 25

"Disadvantages" of corporate structure

Answer 25

- Government regulations (from multiple agencies: state, federal, SEC, Stock Exchange) - Additional taxes (taxed as a separate legal entity) - Corporate management (owners are prevented from having active role in company management)

Question 26

"Advantages" of corporate structure

Answer 26

- Separate legal existence - Limited liability to stockholders - Transferrable ownership rights - Ability to acquire capital (by issuing stock) - Continuous life (not linked to one executive officer or owner)

Question 27

Journaling issuance of shares with Par Value

Answer 27

Issued at Par Value: Debit Cash Credit Common Stock Issued Above Par Value: Debit Cash Credit Common Stock (qty x $/share) Credit Paid-In Capital in excess of Par Value

Question 28

Journaling Issuance of Shares No-Par value

Answer 28

Issued with stated value: Debit Cash Credit Common Stock (qty x $/share) Credit Paid-In Capital in excess of stated value (if issued above stated value) If no par or stated value Debit Cash Credit Common Stock

Question 29

Organization Costs

Answer 29

Expensed as occur: - legal fees - state incorporation fees - promotional costs

Question 30

Corporate vs. Proprietor/ Partnership Capital

Answer 30

Proprietorship/ Partnership - all income flows to owner Corporation - income is property of business Proprietorship - one capital account Partnership - one capital account per partner Corporation- common stock account vs retained earnings account (all are owner's equity accounts so all have credit normal balance)

Question 31

Steps in accounting for issuance of common stock

Answer 31

1) identify source of paid-in capital 2) maintain distinction between paid-in capital and retained earnings Effects only paid-in capital accounts and cash/ assets received

Question 32

Issuance of stock for services or assets

Answer 32

Cost = fair market value of shares given up or fair market value of service/ asset received, whichever is more clearly determinable Debit Expense or Asset Credit Common Stock (qty x $/share) Credit APIC if applicable

Question 33

Treasury Stock Transaction

Answer 33

GAAP Cost method is required Repurchasing: treasury stock must be recorded at cost (price paid) Re-issuing: treasury stock received + Profit/ loss effects Profit/loss = $ received less cost paid for treasury stock -no profit /loss : treasury stock reduced - profit: increase paid in capital - loss: decrease paid-in capital first, then retained earnings (no income statement effect)

Question 34

Journaling Repurchasing Treasury Stock

Answer 34

Debit Treasury Stock (qty x $/share) Credit Cash Treasury stock is a contra-asset account that decreases total stockholders equity Always recorded at cost, no reference to par value

Question 35

JounalingRe-Issuance of Treasury Stock

Answer 35

Debit Cash (Debit Paid-in capital Treasury Stock if loss, Retained Earnings if insufficient balance) Credit Treasury Stock (Qty x COST) (Credit paid-In captial treasury stock if excess) No gains or losses from stock transactions - just increase and decreases of assets and equity

Question 36

Paid in Capital from Treasury Stock Account

Answer 36

Increased when treasury stock re-issued above cost, decreased when treasury stock re-issued below cost Can only be decreased to 0 (only decrease by total balance on hand) Any loss in excess of balance available debited to retained earnings

Question 37

Closing Entries for Corporations

Answer 37

Income summary closed to retained earnings Stock, retained earnings, paid-in capital in excess of par are permanent accounts, not closed at the end the financial period.

Question 38

Common Stock on balance sheet

Answer 38

``` Stockholders Equity Paid-In Capital Common Stock Paid-In Capital in excess of Par Value Total Paid In Capital Retained Earnings Total Stockholders Equity ```

Question 39

Common & Preferred Stock on Balance Sheet

Answer 39

Stockholders' Equity Paid-In Capital % Preferred Stock, $ Par Value X shares authorized, X shares issued and outstanding Common Stock, $ Value (par or stated) X shares authorized, X shares issued / outstanding Total Capital Stock Additional paid-in capital is also separated into preferred and common stock

Question 40

Treasury stock on balance sheet

Answer 40

``` Stockholders Equity Paid-In Capital Common Stock Paid-In Capital in excess of Par Value Total Paid In Capital Retained Earnings Total Paid-In Capital and Retained Earnings Less: Treasury Stock (qty @ cost) Total Stockholders Equity ```

Question 41

Reporting stock on the balance sheet

Answer 41

Preferred stock always listed before common Report: Par value shares authorized, shares issued, and shares outstanding for each class of stock Additional Paid-In capital is its own section

Question 42

Stock Terminology GAAP vs IFRS

Answer 42

GAAP | IFRS All Equity that is not paid-in capital | Reserves Common stock | share capital- ordinary Stockholders | shareholders Par Value | Nominal or face value Preferred Stock | Share Capital- Preference Paid-in Capital in excess of par | share premium Retained Earnings Deficit | Accumulated losses Accumulated other comprehensive income | General reserve and other reserve accounts