Financial Accounting and Accounting Standards

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• Corporations Organization, Stock Transactions,
  Dividends, and Retained Earnings

Chapter 11

• Learning Objectives
• After studying this chapter, you should be able
  to
• Identify the major characteristics of a
  corporation.
• Record the issuance of common stock.
• Explain the accounting for treasury stock.
• Differentiate preferred stock from common stock.
• Prepare the entries for cash dividends and stock
  dividends.
• Identify the items reported in a retained
  earnings statement.
• Prepare and analyze a comprehensive stockholders
  equity section.

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Preview of Chapter 11
Financial and Managerial Accounting Weygandt
Kimmel Kieso
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The Corporate Form of Organization
An entity separate and distinct from its owners.

• Classified by Ownership
• Publicly held
• Privately held

• Classified by Purpose
• Not-for-Profit
• For Profit

• McDonalds
• Nike
• PepsiCo
• Google

• Salvation Army
• American Cancer Society

• Cargill Inc.

LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Advantages
Disadvantages
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.
Corporation acts under its own name rather than
in the name of its stockholders.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Limited to their investment.
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Shareholders may sell their stock.
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Corporation can obtain capital through the
issuance of stock.
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Continuance as a going concern is not affected by
the withdrawal, death, or incapacity of a
stockholder, employee, or officer.
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Corporations pay income taxes as a separate legal
entity and in addition, stockholders pay taxes on
cash dividends.
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Characteristics that distinguish corporations
from proprietorships and partnerships.

• Separate Legal Existence
• Limited Liability of Stockholders
• Transferable Ownership Rights
• Ability to Acquire Capital
• Continuous Life
• Government Regulations
• Additional Taxes
• Corporate Management

Separation of ownership and management prevents
owners from having an active role in managing the
company.
LO 1 Identify the major characteristics of a
corporation.
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Characteristics of a Organization
Stockholders
Illustration 11-1 Corporation organization chart
Chairman and Board of Directors
President and Chief Executive Officer
General Counsel and Secretary
Vice President Marketing
Vice President Finance/Chief Financial Officer
Vice President Operations
Vice President Human Resources
Treasurer
Controller
LO 1 Identify the major characteristics of a
corporation.
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Forming a Corporation
Initial Steps

• Formed by grant of a state charter.
• Corporation develops by-laws.

Companies generally incorporate in a state whose
laws are favorable to the corporate form of
business (Delaware, New Jersey). Corporations
expense organization costs as incurred.
LO 1 Identify the major characteristics of a
corporation.
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Ownership Rights of Stockholders
Stockholders have the right to
Illustration 11-3
1. Vote in election of board of directors and on
actions that require stockholder approval.
2. Share the corporate earnings through receipt
of dividends.
LO 1 Identify the major characteristics of a
corporation.
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Ownership Rights of Stockholders
Stockholders have the right to
Illustration 11-3
3. Keep the same percentage ownership when new
shares of stock are issued (preemptive right).
A number of companies have eliminated the
preemptive right.
LO 1 Identify the major characteristics of a
corporation.
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Ownership Rights of Stockholders
Stockholders have the right to
Illustration 11-3
4. Share in assets upon liquidation in proportion
to their holdings. This is called a residual
claim.
LO 1 Identify the major characteristics of a
corporation.
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Ownership Rights of Stockholders
Illustration 11-4
Prenumbered
Class A COMMON STOCK
Class A COMMON STOCK
Class
PAR VALUE 1 PER SHARE
PAR VALUE 1 PER SHARE
Name of corporation
Stockholders name
Shares
Stock Certificate
Signature of corporate official
LO 1
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Stock Issue Considerations
Authorized Stock

• Charter indicates the amount of stock that a
  corporation is authorized to sell.
• Number of authorized shares is often reported in
  the stockholders equity section.

LO 1 Identify the major characteristics of a
corporation.
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Stock Issue Considerations
Issuance of Stock

• Corporation can issue common stock directly to
  investors or indirectly through an investment
  banking firm.
• Factors in setting price for a new issue of
  stock
• Companys anticipated future earnings.
• Expected dividend rate per share.
• Current financial position.
• Current state of the economy.
• Current state of the securities market.

LO 1 Identify the major characteristics of a
corporation.
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Stock Issue Considerations
Market Value of Stock

• Stock of publicly held companies is traded on
  organized exchanges.
• Interaction between buyers and sellers determines
  the prices per share.
• Prices tend to follow the trend of a companys
  earnings and dividends.
• Factors beyond a companys control, may cause
  day-to-day fluctuations in market prices.

LO 1 Identify the major characteristics of a
corporation.
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Stock Issue Considerations
Par and No-Par Value Stock

• Years ago, par value determined the legal capital
  per share that a company must retain in the
  business for the protection of corporate
  creditors.
• Today many states do not require a par value.
• No-par value stock is quite common today.
• In many states the board of directors assigns a
  stated value to no-par shares.

LO 1 Identify the major characteristics of a
corporation.
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Corporate Capital
Common Stock Account
Paid-in Capital
Paid-in Capital in Excess of Par Account
Preferred Stock Account
Two Primary Sources of Equity
Retained Earnings Account
Paid-in capital is the total amount of cash and
other assets paid in to the corporation by
stockholders in exchange for capital stock.
LO 1 Identify the major characteristics of a
corporation.
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Corporate Capital
Common Stock Account
Paid-in Capital
Paid-in Capital in Excess of Par Account
Preferred Stock Account
Two Primary Sources of Equity
Retained Earnings Account
Retained earnings is net income that a
corporation retains for future use.
LO 1 Identify the major characteristics of a
corporation.
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Corporate Capital
Comparison of the owners equity (stockholders
equity) accounts reported on a balance sheet for
a proprietorship, and a corporation.
Illustration 11-6
LO 1 Identify the major characteristics of a
corporation.
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Accounting for Common Stock Issues

• Primary objectives
• Identify the specific sources of paid-in capital.
  
• Maintain the distinction between paid-in capital
  and retained earnings.

Other than consideration received, the issuance
of common stock affects only paid-in capital
accounts.
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Issuing Par Value Common Stock for Cash
Illustration Assume that Hydro-Slide, Inc.
issues 2,000 shares of 1 par value common stock.
Prepare Hydro-Slides journal entry if (a) 1,000
share are issued for 1 per share, and (b) 1,000
shares are issued for 5 per share.
a)
Cash 1,000
Common stock (1,000 x 1) 1,000
b)
Cash 5,000
Common stock (1,000 x 1) 1,000
Paid-in capital in excess of par value 4,000
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Illustration 11-7
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Issuing No-Par Common Stock for Cash
Illustration Assume that instead of 1 par
value stock, Hydro-Slide, Inc. has 5 stated
value no-par stock and the company issues 5,000
shares at 8 per share for cash.
Cash 40,000 Common stock 25,000 Paid-in
capital in excess of stated value 15,000
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Issuing No-Par Common Stock for Cash
Illustration What happens when no-par stock
does not have a stated value?
Cash 40,000 Common stock 40,000
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Issuing Common Stock for Services or Noncash
Assets

• Corporations also may issue stock for
• Services (attorneys or consultants).
• Noncash assets (land, buildings, and equipment).

Cost is either the fair market value of the
consideration given up, or the fair market value
of the consideration received, whichever is more
clearly determinable.
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Illustration Attorneys have helped Jordan
Company incorporate. They have billed the
company 5,000 for their services. They agree to
accept 4,000 shares of 1 par value common stock
in payment of their bill. At the time of the
exchange, there is no established market price
for the stock. Prepare the journal entry for
this transaction.
Organizational expense 5,000
Common stock (4,000 x 1) 4,000
Paid-in capital in excess of par 1,000
LO 2 Record the issuance of common stock.
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Accounting for Common Stock Issues
Illustration Athletic Research Inc. is an
existing publicly held corporation. Its 5 par
value stock is actively traded at 8 per share.
The company issues 10,000 shares of stock to
acquire land recently advertised for sale at
90,000. Prepare the journal entry for this
transaction.
Land (10,000 x 8) 80,000
Common stock (10,000 x 5) 50,000
Paid-in capital in excess of par 30,000
LO 2 Record the issuance of common stock.
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ANATOMY OF A FRAUD
The president, chief operating officer, and chief
financial officer of SafeNet, a software
encryption company, were each awarded employee
stock options by the companys board of directors
as part of their compensation package. Stock
options enable an employee to buy a companys
stock sometime in the future at the price that
existed when the stock option was awarded. For
example, suppose that you received stock options
today, when the stock price of your company was
30. Three years later, if the stock price rose
to 100, you could exercise your options and
buy the stock for 30 per share, thereby making
70 per share. After being awarded their stock
options, the three employees changed the award
dates in the companys records to dates in the
past, when the companys stock was trading at
historical lows. For example, using the previous
example, they would choose a past date when the
stock was selling for 10 per share, rather than
the 30 price on the actual award date. In our
example, this would increase the profit from
exercising the options to 90 per share.
Total take 1.7 million
The Missing Control Independent internal
verification. The companys board of directors
should have ensured that the awards were properly
administered. For example, the date on the
minutes from the board meeting could be compared
to the dates that were recorded for the awards.
In addition, the dates should again be confirmed
upon exercise.
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Accounting for Treasury Stock
Common Stock Account
Paid-in Capital
Paid-in Capital in Excess of Par Account
Preferred Stock Account
Two Primary Sources of Equity
Retained Earnings Account
Less Treasury Stock Account
LO 3 Explain the accounting for treasury stock.
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Accounting for Treasury Stock
Treasury stock - corporations own stock that it
has reacquired from shareholders, but not retired.

• Corporations purchase their outstanding stock
• To reissue the shares to officers and employees
  under bonus and stock compensation plans.
• To enhance the stocks market value.
• To have additional shares available for use in
  the acquisition of other companies.
• To increase earnings per share.

LO 3 Explain the accounting for treasury stock.
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Accounting for Treasury Stock
Purchase of Treasury Stock

• Debit Treasury Stock for the price paid to
  reacquire the shares.
• Treasury stock is a contra stockholders equity
  account, not an asset.
• Purchase of treasury stock reduces stockholders
  equity.

LO 3 Explain the accounting for treasury stock.
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Accounting for Treasury Stock
Illustration 11-8
Illustration On February 1, 2014, Mead acquires
4,000 shares of its stock at 8 per share.
Treasury stock (4,000 x 8) 32,000
Cash 32,000
LO 3 Explain the accounting for treasury stock.
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Accounting for Treasury Stock
Stockholders Equity with Treasury stock
Illustration 11-9
Both the number of shares issued (100,000),
outstanding (96,000), and the number of shares
held as treasury (4,000) are disclosed.
LO 3 Explain the accounting for treasury stock.
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Accounting for Treasury Stock
Disposal of Treasury Stock
Sale of Treasury Stock

• Above Cost
• Below Cost
• Both increase total assets and stockholders
  equity.

LO 3 Explain the accounting for treasury stock.
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Above Cost
Accounting for Treasury Stock
Illustration On July 1, Mead sells for 10 per
share 1,000 shares of its treasury stock,
previously acquired at 8 per share.
July 1
Cash 10,000
Treasury stock 8,000
Paid-in capital treasury stock 2,000
A corporation does not realize a gain or suffer a
loss from stock transactions with its own
stockholders.
LO 3 Explain the accounting for treasury stock.
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Below Cost
Accounting for Treasury Stock
Illustration On Oct. 1, Mead sells an
additional 800 shares of treasury stock at 7 per
share.
Oct. 1
Cash 5,600
Paid-in capital treasury stock 800
Treasury stock 6,400
Illustration 11-10
LO 3 Explain the accounting for treasury stock.
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Below Cost
Accounting for Treasury Stock
Illustration On Dec. 1, assume that Mead, Inc.
sells its remaining 2,200 shares at 7 per share.
Dec. 1
Cash 15,400
Limited to balance on hand
Paid-in capital treasury stock 1,200
Retained earnings 1,000
Treasury stock 17,600
LO 3 Explain the accounting for treasury stock.
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Accounting for Preferred Stock

• Features often associated with preferred stock.
• Preference as to dividends.
• Preference as to assets in liquidation.
• Nonvoting.

Accounting for preferred stock at issuance is
similar to that for common stock.
LO 4 Differentiate preferred stock from common
stock.
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Accounting for Preferred Stock
Illustration Stine Corporation issues 10,000
shares of 10 par value preferred stock for 12
cash per share. Journalize the issuance of the
preferred stock.
Cash 120,000
Preferred stock (10,000 x 10) 100,000
Paid-in capital in excess of par
Preferred stock 20,000
Preferred stock may have a par value or no-par
value.
LO 4 Differentiate preferred stock from common
stock.
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Accounting for Preferred Stock
Dividend Preferences

• Right to receive dividends before common
  stockholders.
• Per share dividend amount is stated as a
  percentage of the preferred stocks par value or
  as a specified amount.
• Cumulative dividend holders of preferred stock
  must be paid their annual dividend plus any
  dividends in arrears before common stockholders
  receive dividends.

LO 4 Differentiate preferred stock from common
stock.
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Accounting for Preferred Stock
Cumulative Dividend
Illustration Scientific Leasing has 5,000
shares of 7, 100 par value, cumulative
preferred stock outstanding. Each 100 share pays
a 7 dividend (.07 x 100). The annual dividend
is 35,000 (5,000 x 7 per share). If dividends
are two years in arrears, preferred stockholders
are entitled to receive the following dividends
in the current year.
LO 4 Differentiate preferred stock from common
stock.
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Accounting for Preferred Stock
Liquidation Preferences

• Most preferred stocks have a preference on
  corporate assets if the corporation fails.
• Provides security for the preferred stockholder.
• Preference to assets may be for the par value of
  the shares or for a specified liquidating value.

LO 4 Differentiate preferred stock from common
stock.
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Dividends
Distribution of cash or stock to stockholders on
a pro rata (proportional) basis. Types of
Dividends

1. Cash dividends.
2. Property dividends.

1. Stock dividends.
2. Scrip.

Dividends expressed (1) as a percentage of the
par or stated value, or (2) as a dollar amount
per share.
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Three dates
Illustration 11-12
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Cash Dividends

• For a corporation to pay a cash dividend, it must
  have
• Retained earnings - Payment of cash dividends
  from retained earnings is legal in all states.
• Adequate cash.
• A declaration of dividends by the Board of
  Directors.

LO 5 Prepare the entries for cash dividends and
stock dividends.
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Cash Dividends

• Illustration On Dec. 1, the directors of Media
  General declare a 50 per share cash dividend on
  100,000 shares of 10 par value common stock. The
  dividend is payable on Jan. 20 to shareholders of
  record on Dec. 22.

December 1 (Declaration Date)
Cash dividends 50,000
Dividends payable 50,000
No entry
December 22 (Date of Record)
January 20 (Payment Date)
Dividends payable 50,000
Cash 50,000
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends

• Allocating Cash Dividends Between Preferred and
  Common Stock

Holders of cumulative preferred stock must be
paid any unpaid prior-year dividends before
common stockholders receive dividends.
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Illustration On December 31, 2014, IBR Inc. has
1,000 shares of 8, 100 par value cumulative
preferred stock. It also has 50,000 shares of
10 par value common stock outstanding. At
December 31, 2014, the directors declare a 6,000
cash dividend. Prepare the entry to record the
declaration of the dividend.
Cash dividends 6,000
Dividends payable 6,000
Pfd Dividends 1,000 shares x 100 par x 8
8,000
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Illustration At December 31, 2015, IBR declares
a 50,000 cash dividend. Show the allocation of
dividends to each class of stock.
50,000
2,000

8,000

40,000
1,000 shares x 100 par x 8 8,000
2012 Pfd. dividends 8,000 declared 6,000
2,000
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Illustration At December 31, 2015, IBR declares
a 50,000 cash dividend. Prepare the entry to
record the declaration of the dividend.
Cash dividends 50,000
Dividends payable 50,000
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Stock Dividends
Illustration 11-14
Pro rata distribution of the corporations own
stock.
Results in decrease in retained earnings and
increase in paid-in capital.
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Stock Dividends

• Reasons why corporations issue stock dividends
• Satisfy stockholders dividend expectations
  without spending cash.
• Increase marketability of the corporations
  stock.
• Emphasize a portion of stockholders equity has
  been permanently reinvested in the business.

LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Stock Dividends

• Small stock dividend (less than 2025 of the
  corporations issued stock, recorded at fair
  market value)
• Large stock dividend (greater than 2025 of
  issued stock, recorded at par value)

Accounting based on the assumption that a
small stock dividend will have little effect on
the market price of the outstanding shares.
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Illustration Medland Corporation has a balance
of 300,000 in retained earnings. It declares a
10 stock dividend on its 50,000 shares of 10
par value common stock. The current fair market
value of its stock is 15 per share.
10 stock dividend is declared
Stock dividends (50,000 x 10 x 15)
75,000
Common stock dividends distributable
50,000
Paid-in capital in excess of par value
25,000
Stock issued
Common stock dividends distributable
50,000
Common stock (50,000 x 10 x 1)
50,000
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Stockholders Equity with Dividends Distributable
Illustration 11-15 Statement presentation of
common stock dividends distributable
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Effects of Stock Dividends
Illustration 11-16
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Question

• Which of the following statements about small
  stock dividends is true?
• A debit to Stock Dividends for the par value of
  the shares issued should be made.
• A small stock dividend decreases total
  stockholders equity.
• Market value per share should be assigned to the
  dividend shares.
• A small stock dividend ordinarily will have no
  effect on book value per share of stock.

LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Question

• In the stockholders equity section, Common Stock
  Dividends Distributable is reported as a(n)
• deduction from total paid-in capital and retained
  earnings.
• current liability.
• deduction from retained earnings.
• addition to capital stock.

LO 5 Prepare the entries for cash dividends and
stock dividends.
71
Dividends
Stock Split

• Reduces the market value of shares.
• No entry recorded for a stock split.
• Decrease par value and increase number of shares.

LO 5 Prepare the entries for cash dividends and
stock dividends.
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Dividends
Effects of Stock Splits
Illustration 11-17
LO 5 Prepare the entries for cash dividends and
stock dividends.
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Retained Earnings

• Net income increases Retained Earnings and a net
  loss decreases Retained Earnings.
• Part of the stockholders claim on the total
  assets of the corporation.
• Debit balance in Retained Earnings is identified
  as a deficit.

Illustration 11-20
LO 6 Identify the items reported in a retained
earnings statement.
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Retained Earnings
Retained Earnings Restrictions

• Restrictions can result from
• Legal restrictions.
• Contractual restrictions.
• Voluntary restrictions.

Companies generally disclose retained earnings
restrictions in the notes to the financial
statements.
LO 6 Identify the items reported in a retained
earnings statement.
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Retained Earnings
Prior Period Adjustments

• Correction of an error in previously issued
  financial statements.
• Result from
• mathematical mistakes.
• mistakes in application of accounting principles.
• oversight or misuse of facts.
• Adjustment made to the beginning balance of
  retained earnings.

LO 6 Identify the items reported in a retained
earnings statement.
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Retained Earnings Statement
Before issuing the report for the year ended
December 31, 2014, you discover a 50,000 error
(net of tax) that caused the 2013 inventory to be
overstated (overstated inventory caused COGS to
be lower and thus net income to be higher in
2013. Would this discovery have any impact on
the reporting of the Statement of Retained
Earnings for 2014?
LO 6 Identify the items reported in a retained
earnings statement.
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Retained Earnings Statement
LO 6 Identify the items reported in a retained
earnings statement.
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Retained Earnings Statement
Debits and Credits to Retained Earnings
Illustration 11-24
LO 6 Identify the items reported in a retained
earnings statement.
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Retained Earnings Statement
Question

• All but one of the following is reported in a
  retained earnings statement. The exception is
• cash and stock dividends.
• net income and net loss.
• some disposals of treasury stock below cost.
• sales of treasury stock above cost.

LO 6 Identify the items reported in a retained
earnings statement.
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Statement Presentation and Analysis
Presentation
Illustration 11-26
Note R Retained earnings is restricted for the
cost of treasury stock, 80,000.
LO 7
82
Statement Presentation and Analysis
Analysis
Net Income Available to Common Stockholders
Return on Common Stockholders Equity

Average Common Stockholders Equity
Ratio shows how many dollars of net income the
company earned for each dollar invested by the
stockholders.
LO 7 Prepare and analyze a comprehensive
stockholders equity section.