Chapter 20: Corporations: Formation and Capital Stock Transactions

Common and Preferred Stock accounts are credited for par if the stocks carry a par or a stated value.

Any amounts received in excess of the par value are credited to another equity account, PAID-IN CAPITAL in EXCESS of PAR When stock is issued for cash equal to the par value of the shares, cash proceeds are credited to the capital stock account Debit Cash Credit Common stock Credit Preferred Stock

Each share of common stock conveys to the owner the same rights and privileges as every other share including the right to:

1. attend stockholders' meetings, 2. vote in the election of directors and on other matters (each share entitles the owner to one vote), 3. receive dividends as declared by the board of directors, 4. purchase a proportionate amount of any new stock issued at a later date, referred to as the preemptive right

Conversion Ratio example

2 shares of common stock will be issued for every share of preferred stock owned. If a person owned 400 shares of preferred stock before the conversion, they would own 800 shares of common stock after the conversion

2.Restricted Agency. A shareholder has no right to act on behalf of the business. Instead, the board of directors controls the corporation, and the corporate officers are in direct charge of operations.

3. Continuous Existence. The death, disability, or withdrawal of a shareholder has no effect on the life of a corporation.

4. Transferability of Ownership Rights. Generally, shareholders can sell their stock without consulting or obtaining the consent of the other owners. Shareholders are free to shift their investments at any time, provided they can find buyers for their stock. Small companies often sell shares of stock with a contract that gives the corporation or the existing shareholders "the right of first refusal" to repurchase the shares when the shareholder wishes to sell them.

5. Ease of Raising Capital. A corporation can have an unlimited number of shareholders. Some corporations have more than a million shareholders, making available a vast pool of capital.

No-Par-Value Stock: No Stated Value

Corporate charter indicates that stock is no-par-value stock. Stock certificate shows that stock is no-par-value stock. On issue of stock, entire proceeds are credited to capital stock account.

There are many advantages and there are also some disadvantages of forming a business as a corporation Some of the Disadvantages are:

Corporate income tax-A corporation's income is taxed at both the corporate level as well as the shareholder level. Governmental regulation-State regulatory bodies exercise closer supervision and control over corporations. (A corporation has to renew its state charter every year, if it is publicly traded-it must be audited, the SEC requires quarterly reports, etc.)

The balance shows the number of shares held. The ledger sheets can also include a record of dividends.

For each class of stock, the stockholders' ledger is a subsidiary to the capital stock account. The total shares shown in the stockholders' ledger must agree with the number of shares in the capital stock account for that class.

Record transactions for stock subscriptions.

For example: Subscriptions Debit Receivable-Common Credit Common Stock Subscribed

Subchapter S Corporation

Known as S corporation Meets Subchapter S requirements of Internal Revenue Code to be treated as a partnership The S corporation does not pay income taxes Shareholders include their share of corporate profits on their individual tax returns

No-par stock with a stated value is accounted for as though the stated value is its par value.

Notice that the excess cash received beyond the stated value of the stock is credited to a new account called, Paid-in Capital in Excess of Stated value

Unlike a proprietorship or a partnership, a corporation cannot just open its doors and begin business operations.

Permission must be obtained from the state. In addition, the new corporation may have to register with various taxing authorities

DIVIDENDS ON PREFERRED STOCK Preferred stock has a priority with respect to dividends. The priority is specified in the corporate charter.

Preferred stock bears a basic or stated dividend rate, called the preference dividend, that must be paid before dividends can be paid on common stock.

Why is preferred stock called "preferred"?

Preferred stock is entitled to a dividend before a dividend is paid on common stock. It may also have certain preferences over distribution of assets in the case of liquidation. In addition, there is a reasonable assurance of a constant and predictable income from dividends.

Common-If there is only one class of stock, common stock is issued. Each share carries the same rights and privileges as every other share

Preferred stock-has special claims on a corporation's profits or, in case of liquidation, corporate assets Preferred shareholders usually cannot vote

Paid-in Capital in Excess of Par Value—Preferred Stock or.........

Premium on Preferred Stock or a similar name.)

Common stock dividends are paid only after preferred dividend requirements have been met.

The fewer the dividend privileges enjoyed by preferred stockholders, the higher the dividends that common stockholders can receive, especially in prosperous years.

If a corporation has two or more classes of stock, one class must be common.

The other class or classes of stock typically will have certain preferences over the common shares.

Flow of Corporate Authority and Responsibility

Stockholders: Elect directors Directors: Make policies Appoint officers Officers: Carry out policies Hire managers Managers: Oversee and supervise daily operations Other employees: Perform assigned tasks

Stock is issued after the purchaser has paid for it in full with one of the following: Cash, Noncash assets, Services rendered

Stocks are issued either with or without par value. In most states, Par value is minimum amount that the stock can be "sold" for

Hybrid business entities

Subchapter S corporation Limited liability partnerships (LLP) Limited liability companies (LLCs) Hybrid entities have characteristics of partnerships and corporations

When these entries are posted, the Subscriptions Receivable—Common and Common Stock Subscribed accounts are closed. Both Cash and Common Stock are increased by $10,000:

Subscriptions Receivable—Common Debit May 1 10,000 Credit June 1 10,000 Debit Cash June 1 10,000 Common Stock Subscribed Debit May 1 10,000 Credit June 1 10,000 Common Stock Credit June 1 10,000

important! Stock Subscriptions

Subscriptions receivable accounts are presented in the asset section. Stock subscribed accounts are presented in the Stockholders' Equity section of the balance sheet.

Control Account: 1. Common Stock 2. Preferred Stock 3. Subscriptions Receivable—Common Stock 4. Subscriptions Receivable—Preferred Stock

Subsidiary Ledgers: 1. Common Stockholders' Ledger Contains an account for each owner of common stock and shows shares bought or transferred and the balance of shares owned 2. Preferred Stockholders' Ledger Contains an account for each owner of preferred stock and shows shares bought or transferred and the balance of shares owned 3. Subscribers' Ledger—Common Contains the account receivable for each subscriber to common stock 4. Subscribers' Ledger—Preferred Contains an account receivable for each subscriber to preferred stock

A stock subscription gives the corporation a receivable from the subscriber and an obligation to hold enough stock for issue when the subscription is paid in full

The Common Stock Subscribed account appears in the Stockholder's Equity section of the Balance Sheet. It will remain there until the stock is actually issued The Subscriptions Receivable--Common is an asset reported in the Current Assets section of the balance sheet The Common Stock Subscribed account will be reported in the Stockholders' Equity section of the balance sheet

Preferred stock has a specified dividend rate (preference dividend) that must be paid before dividends can be paid to common stockholders

The Dividend=(par value of preferred stock x dividend rate)

Stockholders can participate in stockholders' meetings, elect a board of directors, and vote on basic corporate policy.

The board of directors formulates general operating policies and is responsible for seeing that the corporation's activities are conducted. The board selects officers and other top management personnel to direct everyday operations. The officers hire managers who hire other employees. Officers and managers make the day-to-day decisions necessary to operate the business.

Convertible Preferred Stock: Owners have the right to convert their shares into common stock after a specified date

The common stock conversion ratio will be indicated on the preferred stock certificate.

When stock is issued for cash equal to the par value of the shares, cash proceeds are credited to the capital stock account.

The receipt of cash was recorded in the cash receipts journal.

Dividends are distributions of the profits of a corporation to its shareholders.

The right to receive a dividend is one of the major incentives for buying stock. The board of directors declares dividends.

The ability to convert preferred stock to common stock can make the preferred stock more attractive to investors.

The decision to convert the preferred stock to common stock depends on the market prices, the relative dividends paid on the common and the preferred stock, and the degree of risk involved.

Common stock dividends, The amount of dividends paid each year reflects such factors as the company's trend of profits and cash flows, tax laws, availability of cash, plans for future expansion, and so on.

Typically, a company avoids decreases in dividend payouts because a decrease often leads to loss of investor confidence and reduced prices for the stock.

Although the advantages of the corporate entity are impressive, the corporate form of operation also has certain disadvantages:

Governmental Regulation. Corporations are subject to laws and regulations imposed by the state. In general, the state regulatory bodies exercise closer supervision and control over corporations than they do over sole proprietorships or partnerships. State laws may prohibit corporations from entering into particular types of transactions or from owning specific types of property. Special reports are frequently required of corporations.

Participating preferred stock

Has right to receive preference dividend each year before any dividend can be paid on common stock After preference dividend is paid, any additional dividend up to specified rate or amount is paid to common stockholders After common shareholders have received the specified dividend, preferred and common stock share in remaining dividends

Mutual funds allow small investors to pool their funds with other small investors. There are many types of mutual funds. Each fund concentrates on a particular type of stock.

Index funds invest in indices like the S&P 500, Russell 1000, or NASDAQ Composite. Growth funds invest in companies that are growing quickly. International funds buy stocks from European and Pacific Rim companies. Bond funds invest in the bond market.

Subchapter S corporations

are entities formed as corporations that meet the requirements of subchapter S of the Internal Revenue Code to be treated essentially as a partnership so the corporate entity pays no income tax. Instead, shareholders include their share of corporate profits, and any items that require special tax treatment, on their individual income tax returns. Otherwise, S corporations have all the characteristics of regular corporations. The primary advantages of S corporations are that the owners have limited liability and avoid double taxation.

Often a corporation will have a predetermined amount of capital that it desires to raise in a stock issue-Stock Subscriptions

are taken to determine whether the corporation will meet its goal A subscription is a contract to purchase shares of stock at a certain price and describes the payment plan to pay for the shares

The subscribers' ledger

contains an account receivable for each stock subscriber. The account is debited for the total subscription and credited when the subscriber makes payments. The subscribers' ledger is a subsidiary ledger. The balances of the individual subscriber accounts must agree with the Subscriptions Receivable control account in the general ledger.

Nonparticipating preferred stock

conveys to its owners the right to only the preference dividend amount specified on the stock certificate.

Cumulative preferred stock

conveys to its owners the right to receive the preference dividend for the current year and any prior years in which the preference dividend was not paid before common stockholders receive any dividends (commonly called dividends in arrears).

Noncumulative preferred stock

conveys to its owners the stated preference dividend for the current year, but stockholders have no rights to dividends for years in which none were declared.

publicly held

corporation has many owners and its stock is traded on an organized stock exchange.

privately held

corporation is one whose stock is not traded on an organized stock exchange.

authorized capital stock

is the number of shares authorized for issue by the corporate charter. Usually the authorized stock is more than the number of shares the corporation plans to issue in the foreseeable future.

Liquidation value In case of liquidation, preferred stockholders have a claim on assets before that of common stockholders.

(usually par value or an amount higher than par value) is assigned to the preferred stock. After the creditors are paid, the preferred stockholders are paid the liquidation value for each share of preferred stock before any assets are distributed to common stockholders.

Let's look at the common characteristics of a corporation

A corporation is considered an artificial person in the eyes of the law. As a separate legal entity, it owns assets and is responsible for paying corporate liabilities. Corporations can have a single owner or it can be owned by millions An owner of a corporation is called a shareholder because they have purchased shares of the company's stock

Corporate charter

A document issued by a state government that establishes a corporation

The amount received by a corporation that is in excess of the par value is called a....... premium.

A premium on preferred stock is credited to an account called Paid-in Capital in Excess of Par Value—Preferred Stock.

Which level of government is responsible for issuing charters for most corporations?

ANSWER State governments issue a vast majority of corporate charters.

What is the role of stockholders in running the business of a corporation?

ANSWER The major role of the stockholders is to choose the directors of the company. Stockholders have no inherent right to represent the corporation or take part in its management.

RealTime Company has outstanding 10,000 shares of 8 percent, $50 par-value, cumulative, preferred stock and 20,000 shares of $25 par-value common stock. There are no dividends in arrears on the preferred stock. In 2019, the corporation distributed dividends of $100,000. How much will be distributed to common stockholders and to preferred stockholders?

Allocation is $40,000 to preferred and $60,000 to common, computed in following order: Step 1: To preferred: 10,000 shares × $4 per share dividend = $40,000. Step 2: To common: All dividend distributions remaining after preferred dividends ($100,000 − $40,000) = $60,000.

Since organization costs have no fixed legal life, these costs would, if capitalized, be an intangible asset requiring it to be amortized over some period (the current tax rule is to amortize the amount over 180 months).

Because of the difficulty estimating an identifiable life and the additional fact that the amount spent for organization costs is typically immaterial, the practice today is to charge organization costs to expense during the first financial reporting period after the corporation begins activities.

STOCK CERTIFICATE BOOKS

Capital stock is usually issued by a corporation in the form of a stock certificate

Capital stock represents the equity in a corporation and is thus reported on the balance sheet

Common stock and preferred stock are reported separately, so readers of the financial statement will have an understanding of who owns the corporation

Stock Classes: Common or Preferred

Common stock is if a corporation only issues one class of stock then it would be common stock. Preferred stock has several preferences over the rights of common stockholders which include the right to receive dividends before common stockholders receive any. They also have preferential rights to the company assets before common stockholders, if the company ceases doing business. Preferred shareholders usually cannot vote

Some preferred stock can be converted into shares of common stock

Convertible preferred stock, is preferred stock that conveys the right to convert that stock to common stock after a specified date or during a period of time

Although the advantages of the corporate entity are impressive, the corporate form of operation also has certain disadvantages:

Corporate Income Tax. Corporate profits are subject to federal income tax. Profits distributed to shareholders in the form of dividends are taxed a second time as part of the personal income of the stockholder. The taxation of profits at the corporate level and at the shareholder level is known as double taxation.

No-Par-Value Stock: No Stated Value

Corporate charter indicates that stock is no-par-value stock Stock certificate shows that stock is no-par-value stock On issue of stock, entire proceeds are credited to capital stock account

Disadvantages of Coporations

Corporate income tax Governmental regulation

If dividends are participating then the stockholders has the right to receive preference dividends each year before any dividends each year before any dividends can be paid on common stockholders and after common shareholders have received their specified amount, preferred and common stock share in further dividends.

Cumulative participating preferred shareholders have all the "extras." Their dividends are paid before any other dividends are paid.

There are various rights which a preferred shareholder may have. When they purchased their shares of preferred stock, the stock certificate may have specified that dividends were:

Cumulative preferred stock Noncumulative preferred stock Nonparticipating preferred stock Participating preferred stock

When the corporate charter was received, the accounting records were established. The following memorandum entry provides the details of the authorized capital stock:

Data relating to each class of stock are entered on ledger sheets:

The stock is issued when full payment has been received for the subscription The first journal entry shows the receipt of cash and the subsequent journal entry shows the issuance of stock:

Debit Cash Credit Subscriptions Receivable Debit Stock Subscribed Common Credit Common Stock

Types of Capital Stock

Decisions about the classes of stock to be offered and the number of shares of each class must be made before the charter application is filed.

Dividends are a return on the common or preferred shareholder's investment Dividends are distributions of the profits of a corporation to its shareholders

Dividends must be declared by the board of directors and there must be a credit balance in retained earnings large enough to cover the declared dividends

A separate series of stock certificates is prepared for each class of stock. A corporation that expects to issue few stock certificates can have them prepared in books.

Each certificate is numbered consecutively and attached to a stub from which it is separated at the time of issuance. The certificate indicates the: name of the corporation, name of the stockholder to whom the certificate was issued, class of stock, number of shares. Certificates are valid when they are properly signed by corporate officers and have the corporate seal affixed to them.

Some states require no-par-value stock to be assigned a stated value.

Even if it is not required, the board of directors can assign a stated value.

Noncumulative, nonparticipating preferred stock

Has right to receive preference dividend each year before any dividend can be paid on common stock If dividend is passed (not paid) in one year, the amount not paid is not cumulative and does not affect dividend payments in future years

Cumulative preferred stock

Has right to receive preference dividend each year before any dividend can be paid on common stock If dividend is passed in one year, the amount not paid carries over and must be paid in subsequent year before any dividend can be paid on common stock

Common stock

If there is only one class of stock

If the corporation has the potential for earning very attractive profits, investors are willing to pay more than par value to become stockholders.

Likewise, if the preferred stock dividend is more attractive than other investments with similar risk, investors are willing to pay more than par value.

Advantages of Corporations

Limited liability Restricted agency Continuous existence Transferability of ownership rights Ease of raising capital

There are many advantages and there are also some disadvantages of forming a business as a corporation Some of the advantages are:

Limited liability-Shareholders have no personal liability for the corporations's debts Restricted agency-A shareholder has no right to act on behalf of the corporation. Instead, the board of directors controls the corporation and management controls its operations Continuous existence-If a shareholder dies, it has no effect on the corporation's life. Transferability of ownership rights-If you don't want to be an owner anymore, all you have to do is sell your shares Ease of raising capital-If a company wants to raise capital, it can sell more stock

Corporations keep detailed records of stockholders' equity and special corporate records such as:

Minutes of meeting of stockholders and directors Corporate bylaws Stock certificate books Stock ledgers Stock transfer records

No-par-value stock has the following theoretical advantages over par-value stock:

No-par-value stock can be issued at any price. Par-value stock cannot be issued for less than its par value. If there is no par value, investors cannot confuse par value and market value.

If Non-Cash assets are received in exchange for stock, then the assets are recorded at their appraised value

Noncash assets include: Merchandise Inventory Land Building Equipment and Fixtures Accounts Receivable The Allowance for Doubtful Accounts is recorded separately The net value of assets transferred is the sum of all noncash assets less liabilities (such as Accounts Payable)

Any excess received over stated value is treated as a premium and credited to

Paid-in Capital in Excess of Stated Value.

Par Value

Par value is an amount assigned by the corporate charter to each share of stock for accounting purposes. Stock can be issued for more than par value.

Par-Value Stock

Par value is specified in corporate charter. Stock certificate indicates par value. Change in par value requires revision of charter. On issue of stock, par value is credited to capital stock account.

Capital Stock Values

Par value-is assigned to each share of stock for accounting purposes. Generally, it is the minimum amount a share can be sold for. Stated value-is assigned to a stock which does not have a par value. It is treated the same as par value. Decision made by the board of directors Market value is the price per share at which the stock is bought or sold

Comparison of Rules for Par-Value and No-Par-Value Stock

Par-Value Stock No-Par-Value Stock -Stated Value -No Stated Value

How does "participating" preferred stock differ from "cumulative" preferred stock?

Participating preferred stock shares with common stock a part of increased dividends in excess of the preferred stock's rate of return. The degree of participation depends on the terms of the stock issue and is beyond the scope of this text. Cumulative preferred stock does not have this right.

When stock is issued for more than its par value, it is issued at a premium

Premiums on stock are usually credited to an account titled "Paid-in Capital in Excess of Par Value" Separate accounts are set up for difference classes of stock Debit Cash Credit Preferred Stock Credit Paid-in Capital in Excess of Par Value-Preferred Stock

Common stock

Receives dividends after preferred stock dividends are paid in accordance with contractual obligation

Subchapter S Corporations

Shareholders include their share of corporate profits on their personal income tax returns. (They receive a K-1 form from the corp, at year end) S corporations have all the characteristics of a regular corporation, like shareholder limited liability, but they avoid the double taxation disadvantage

For this reason, in past years, organization costs have been capitalized and amortized over an arbitrary period (typically the period from the U.S. tax code).

Some corporations, however, simply record the costs as an intangible asset and do not amortize the costs for financial accounting purposes.

The conversion ratio is the number of shares of common stock that will be issued for each share of preferred stock surrendered. The conversion ratio is indicated on the preferred stock certificate.

Some investors are reluctant to purchase preferred stock because its market price does not increase significantly even if the corporation is quite profitable.

Subscriptions for Capital Stock

Some prospective stockholders want to buy stock and pay for it later. They sign a subscription contract that states the stock price and describes the payment plan. They receive the stock when payment is made.

Stated Value

State laws permit stock to be issued without par value. This type of stock is called no-par-value stock. The value that can be assigned to no-par-value stock by a board of directors for accounting purposes

If no-par common stock is issued without a stated value, the entire amount received is credited to the Common Stock account

Stated value has not been assigned the shares First issue was for 1000 shares for $20 per share Second issue was for 600 shares for $22 per share

Since the owners of a corporation are stockholders, the equity section of the balance sheet is titled

Stockholders' Equity

important! In Excess of Par

The amount credited to the Paid-In Capital in Excess of Par Value account is the price paid by the stockholder minus the par value of the stock multiplied by the number of shares issued.

Capital Stock Account

The amount credited to the capital stock account is the par value of the stock issued.

The board of directors has complete discretion, subject to certain legal restrictions or contractual restrictions, in deciding whether to declare a dividend and the amount of the dividend.

The amount of the dividend depends on the corporation's earnings and on the need to keep profits for use in the business. Dividends are usually paid on a quarterly basis.

The balance sheet for a corporation is very similar to other balance sheets we have already seen

The biggest difference between the corporate balance sheet and the balance sheets for sole proprietorship is the Stockholder Equity section. In this partial balance sheet, we see the Stockholders' Equity section. Notice that the number of shares authorized and the number of shares issued is also entered in the stockholder equity section next to each class of stock

After the corporation issues stock, new stockholders purchase shares from existing stockholders. The process is as follows:

The buyer pays the seller. The seller surrenders the stock certificate to the corporation. The corporation issues a new certificate to the buyer.

The liquidation value of preferred stock includes any cumulative dividends that have not been paid. (Cumulative dividends are explained later in this chapter.)

The liquidation preference on preferred stock is disclosed in the Stockholders' Equity section of the balance sheet.

Conversion Ratio

The number of shares of common stock into which a preferred stock can be converted

A corporation's officers include the president, one or more vice presidents, a corporate secretary, and a treasurer.

The top accounting official is called the controller or chief financial officer. Large firms might have several layers of management, including division managers, department heads, and supervisors. The levels depend on the nature and complexity of the operations.

Subsidiary Ledgers

The total of the individual accounts must agree with the control account in the general ledger.

Corporations whose stock is widely held and actively traded do not keep their own stockholder records. Instead, they turn the responsibility over to a transfer agent and a registrar.

The transfer agent receives the stock certificates surrendered. A bank that serves as a transfer agent is often chosen for its proximity to the stock exchange or market where the corporation's stock is expected to trade. The same bank may also be appointed registrar.

To keep the required information, corporations set up a capital stock ledger, or stockholders' ledger for each class of stock issued.

There is a sheet for each stockholder with the following information: stockholder's name and address, dates of transactions affecting stock holdings, certificate numbers, number of shares for each transaction.

Its ownership interests are not freely transferable with a LLC; other owners must approve a transfer of ownership interest.

When transferring ownership, the existing LLC is terminated and a new one formed. LLC owners can take part in policy and operating decisions. LLCs are formed and operate under state laws and regulations.

Court Company has outstanding 10,000 shares of 10 percent, $50 par-value, cumulative, nonparticipating preferred stock and 25,000 shares of $20 par-value common stock. No dividends were declared in 2019. In 2020, the directors voted to distribute dividends of $48,000. What amount of dividends, if any, will be distributed to holders of preferred stock? What amount, if any, will be distributed to holders of common stock?

a. Preferred shareholders will receive the entire $48,000 in 2020. There is a carryover of $52,000 that preferred must receive in addition to future preferred dividend requirements before any dividends can be paid to common stockholders. b. Common shareholders will receive nothing in 2020.

The registrar

accounts for all the stock issued by the corporation and makes sure that the corporation does not issue more shares than are authorized. The registrar receives from the transfer agent all the canceled certificates and all the new certificates issued. The registrar must countersign the new certificates before they are valid.

Organization costs

are incurred to provide benefit over the entire life of the corporation because they are necessary in order for the entity to exist and carry on business.

If the preferred shareholders are entitled to receive the preference rate, and in addition to share in any further dividends declared in a year, the stock is known as: a. cumulative. b. participating. c. nonparticipating. d. quasi-common.

b. participating.

An assignment form on the certificate indicates to whom a new certificate should be issued. The agent:

cancels the old certificates, issues the new ones, makes the necessary entries in the capital stock ledger, prepares lists of stockholders who should receive dividend payments and notices. The agent might also prepare and mail the dividend checks.

Stock is issued after the purchaser has paid for it in full with one of the following:

cash noncash assets services rendered

Participating preferred stock

conveys the right not only to the preference dividend amount but also to a share of other dividends paid

If no-par-value stock does not have a stated value, the proceeds from the issue of shares are.....

credited to the Common Stock account.

Common stockholders receive remaining dividends only after....

dividends have been paid on preferred stock in accordance with contractual obligations

Callable preferred stock

gives the issuing corporation the right to repurchase the preferred shares from the stockholders at a specific price. The call price is usually substantially greater than the original issue price. The rights are effective after some specified date. Callable stock gives the corporation flexibility in controlling its capital structure.

Preferred stock

has special claims on the corporate profits or, in case of liquidation, on corporate assets. In receiving special preferences, the owners of preferred stock might lose some of their general rights, such as the right to vote. Unless the charter specifies otherwise, however, preferred stock has voting rights.

limited liability partnership (LLP)

is a general partnership that provides some limited liability for all partners. LLP partners are responsible and have liability for their own actions and the actions of those under their control or supervision. They are not liable for the actions or malfeasance of another partner. LLPs must have more than one owner, so a sole proprietorship cannot be treated as one.

A shareholder or stockholder

is a person who owns shares of stock in a corporation and is, thus, one of the owners of the corporation.

The capital stock transfer journal

is a record of stock transfers used for posting to the stockholders' ledger. There is a capital stock transfer journal for each class of stock issued by the corporation.

The dividend rate

is expressed in dollars-per-share per year or as a percentage. When the dividend is expressed as a percentage, the dividend amount is par value of the stock multiplied by the percentage.

No-par-value stock

is not assigned a par value in the corporate charter.

Convertible preferred stock

is preferred stock that conveys the right to convert that stock to common stock after a specified date or during a period of time.

Market Value

is the price per share at which stock is bought and sold. After the corporation issues stock, it can be resold for any price that can be agreed on between the shareholder and purchaser. Usually a stock's market value has little relation to its par or stated value.

A minute book

keeps accurate and complete records of all meetings of stockholders and directors. The minute book formally reports actions taken, directives issued, directors elected, officers elected, and other matters.

Corporations keep detailed records of stockholders' equity. They maintain special corporate records such as:

minutes of meetings of stockholders and directors, corporate bylaws, stock certificate books, stock ledgers, stock transfer records.

If dividends are NONPARTICIPATING then the stockholder has the right to receive preference dividends each year before any dividends an be paid on common stock

or to common stockholders, but they do not have the right to any dividends in excess of the preference dividend

Limited liability companies (LLCs)

provide limited liability to the owners, who can elect to have the profits taxed at the LLC level or on their individual income tax returns. The profits and losses can be allocated to the owners other than in proportion to the ownership interests. In most states, one individual can form an LLC.

A stock subscription is recorded as a.....

receivable from the subscriber The corporation must have stock available to issue when the subscription is paid in full.

The corporate equivalent of owner's equity is called.....

stockholders' equity or shareholders' equity.

The corporation tracks stock subscriptions using the subscription book and the subscribers' ledger.

subscription book is a listing of the stock subscriptions received, shows the names and addresses of the subscribers, shows the number of shares subscribed, contains the amounts and times of payment.

A minute Book- is the official diary of the corporation and

the depository of official actions of the board of directors, kept by the corporate attorney or secretary. (Keeps the minutes of the stockholder meetings)

If dividends are NONCUMULATIVE then the stockholder has the right to receive preference dividends each year before any dividends can be paid to common stockholders but....

they have no rights to dividends for years in which none were declared

The general formation steps include:

1. A (corporate charter) must be filed. It specifies name, length of life, rights and duties, scope of operation, classes of stock and number of shares in each class. 2. Board of directors is elected 3. Corporation issues shares of stock in exchange for cash or other assets 4. The stockholders elect a permanent set of directors. (The directors or shareholders approve the corporation's bylaws) 5. The directors select officers who will hire employees so that the company can begin doing business

The corporate form offers some major advantages:

1. Limited Liability. Sole proprietors and general partners have unlimited liability; they are personally liable for all debts of the business. Shareholders have no personal liability for the corporation's debts. The corporation's creditors must look to the assets of the business to satisfy their claims, not to the owners' personal property, even in the event of liquidation.

When dividends are paid, they are paid in the following order:

1. To holders of cumulative preferred stock for prior year dividends (oldest year first) not paid (commonly called dividends in arrears). 2. To preferred stockholders for the preference dividend for the current year. 3. To common stockholders.

Lucia Torrez and her husband, Juan, are sole shareholders in a corporation they formed to operate their existing chain of five restaurants. Their corporation earned net income of approximately $150,000 in its first year of operations. One of Lucia's friends suggested to her that she and Juan had made a mistake in incorporating and should operate as a sole proprietorship or partnership. What reasons may Lucia use to support their decision to incorporate?

ANSWER They have escaped the legal liability associated with a partnership or sole proprietorship. In addition, they can sell the corporation or part of it without any legal problems of continuity of the business. In addition, it is much easier to find persons to purchase an ownership interest (stock) in a corporation than undivided interests in a partnership.

What are the primary advantages of the corporate form of business?

ANSWER The primary advantage of the corporate form is that owners generally have no legal liability for the debts of the corporation. Additional benefits are the ease of transferring ownership interests and the fact that the death of a shareholder does not terminate the business.

The stockholders of a corporation: a. have power to act for the business unless specifically prohibited by the corporate charter. b. are generally liable for the debts of the corporation. c. can sell their shares of stock without permission from other stockholders. d. are forbidden to be employees of the corporation.

ANSWER c. can sell their shares of stock without permission from other stockholders.

In a corporate organization, the stockholders: a. must pay federal income tax on their proportional shares of profits reported by the corporation. b. have the right to surrender preferred stock to the corporation at any time for a payment equal to the par value of the stock. c. elect the directors of the corporation. d. are entitled to a proportionate share of dividends declared on their classes of stock.

ANSWER c. elect the directors of the corporation. d. are entitled to a proportionate share of dividends on their classes of stock.

MANAGERIAL IMPLICATIONS << CORPORATION CONSIDERATIONS In order to select the most beneficial capital structure, management needs to be familiar with the various classes of stock. Management is responsible for ensuring the following:

Assets acquired through the issue of stock are recorded at fair market value so that the corporation's profitability can be properly computed and evaluated. Capital stock issues are properly recorded and tracked. Stock subscriptions are in conformity with state laws and the accounting records fully reflect all information relating to stock subscriptions. The corporation has adequate records to comply with legal requirements and to track stockholder transactions. Officers act within the limitations set by the board of directors and the shareholders. The bylaws and charter provisions of the corporation are carefully followed, and minutes are kept of all meetings of directors and stockholders. Management needs to be aware that state laws prohibit the issuance of stock at less than par value. Management must be aware that actions of the board of directors, as reported in the corporate minutes, often have accounting effects.

Capital Stock

Authorized shares: The number of shares that can be sold (maximum) Issued shares: The number of shares that have been sold Outstanding shares: The number of shares still in circulation Outstanding stock = Issued stock - Treasury stock

Common characteristics of a corporation

Created by corporate charter issued by a state government Can enter into contracts and own property Can have few or many owners Can be privately held or publicly held Has shareholders who own the shares of stock They are the owners of the corporation

In some states, LLPs are for the service professions only, such as law, accounting, medicine, and engineering.

Except for the limited liability aspect, LLPs generally have the same characteristics, advantages, and disadvantages as any other partnership.

The conversion feature makes the preferred stock more attractive to investors

If a stock is (callable), then the corporation has the right to repurchase it from the owner at a specified price. Callable stock gives the corporation flexibility in controlling its capital structure

If dividends are CUMULATIVE then the stockholder has the right to receive preference dividend each year before any dividend can be paid on common stock

If dividend is passed (not paid) in one year, the amount not paid carries over and must be fully paid in a subsequent year before any dividend can be paid on common stock

Most no-par-value stock is assigned a stated value by the board of directors. The stated value is treated like par value.

If no-par-value common stock with a stated value is issued at a price higher than the stated value, the stated value is credited to the Common Stock account.

In what ways, if any, may common stock be preferable to preferred stock?

If things go well, and large dividends are paid, common shares usually benefit from the large distribution while preferred shares do not. Participating preferred stock may be issued that provides that preferred shares participate in the higher dividends.

State and local governments can also levy income taxes on corporations.

In addition, most states require corporations to pay an annual franchise tax for the privilege of carrying on business in the state. In some states, especially those that have no corporate income tax, the franchise tax can be quite burdensome.

After a corporate charter is issued

Organizers elect an acting board of directors-> Shares are issued to individuals who have paid full purchase price of the stock-> Shareholders elect permanent directors-> Directors or shareholders approve bylaws-> Board selects corporate officers-> Officers hire employees and begin operations

When a corporation issues stock, the stock is sold (transferred to stockholders).

Outstanding stock is stock that has been issued and is still in circulation, meaning it is still in the hands of stockholders.

Limited Liability Company (LLC)

Owners have limited liability Owners choose to have profits taxed at the company level or on their individual income tax return Profits and losses can be allocated other than in proportion to ownership interest Transfers of ownership must be approved by owners

There are three terms commonly used to describe stock values.

Par Value Stated Value Market Value

Limited Liability Partnership (LLP)

Partners are responsible and have liability for their own actions and actions of those they control or supervise Partners are no liable for the actions or malfeasance of another partner (They are not responsible for the actions of another partner)

No-Par-Value stock: Stated Value

Stated value is assigned by directors. Corporate charter indicates that stock is no-par-value stock Stock certificate does not generally show state value Stated value can be changed by directors On issue of stock, stated value is credited to capital stock account

No-Par-Value Stock: Stated Value

Stated value is assigned by directors. Corporate charter indicates that stock is no-par-value stock. Stock certificate generally does not show stated value. Stated value can be changed by directors. On issue of stock, stated value is credited to capital stock account.

Par-Value Stock, Par value is specified in corporate charter

Stock certificate indicates par value Change in par value requires revision of charter On issue of stock, par value is credited to capital stock account

Some prospective stockholders want to buy stock and pay for it later. They sign a subscription contract that states the stock price and describes the payment plan

Stockholder signs a subscription contract. (It details stock price and payment plan) Stockholder pays for stock at a later date Stockholder receives stock when payment is made

When a corporation is formed it incurs many organization costs. Organization costs are costs associated with establishing a corporation such as legal fees, attorneys' fees, charter fees, and costs of the organizational meeting with the directors

The usual practice today is to expense organization costs during the first financial reporting period after the corporation begins activities. If stock is issued in exchange for services performed in getting the corporation ready for business, then the FMV of the services is debited to Organizational Expense Debit Organization Expenses Credit Cash

It is essential for corporations to keep accurate records of the shares of stock issued and the names and addresses of the stockholders.

This information is needed to mail dividend checks and official notices about stockholders' meetings and votes.

How to record organization cost

This reimbursement is recorded by a debit to Organization Expense and a credit to Cash.

When the subscriptions are paid in full, the stock is issued.

Until then, the Stock Subscribed accounts appear in the Stockholders' Equity section of the balance sheet as additions to the class of stock issued.