CHAPTER 11 END Q'S
What is meant by the phrase separate legal entity? To which type of business organization does it apply?
"Separate legal entity" means that the business organization operates separately from its owners. Corporations are separate legal entities created by the authority of the government.
What are the three major forms of business organizations?
1. Sole Proprietorship 2. Partnership 3. Corporation
Why might a company repurchase its own stock?
1. to have stock available to give employees pursuant to stock option plans 2. to accumulate stock in preparation for a merger or business combination 3. to reduce the number of shares outstanding in order to increase earnings per share 4. to keep the price of the stock high when it appears to be falling 5. to avoid a hostile takeover (removing shares from the open market reduces the opportunity for outsiders to obtain enough voting shares to gain control of the company
Preferred Stock
A class of stock that is given preferential treatment over common shareholders in some matters, usually in the distribution of earnings; however, they give up other shareholder rights including usually having no voting rights and the amount of their dividends is usually limited
Common Stock
A class of stock that possesses certain rights usually not given other classes of stock; these include: 1. the right to buy and sell stock 2. the right to share in the distribution of profits 3. the right to share in the distribution of corporate assets upon liquidation 4. the right to vote on certain matters that affect the corporate charter 5.the right to participate in the selection of directors for the corporation
How are Sole Proprietorships formed?
A sole proprietorship is formed when an individual decides to engage in some activity that provides goods or services, with the intent of making a profit; they establish the proprietorship by obtaining a business license from a local government authority (no legal ownership agreement required).
Why would a company choose to distribute a stock dividend instead of a cash dividend?
A stock dividend is declared to either compensate shareholders when cash is not available or lower the market price of a share of stock
What is the difference between a stock dividend and a stock split?
A stock dividend is when companies distribute additional shares of stock to the stockholders (ie they do not pay the dividends in cash); used to give shareholders some reward when the corporation does not have sufficient cash to distribute; gives each shareholder additional shares in proportion their stock ownership; after the stock dividend, each shareholder owns exactly the same proportion of the corp. he owned before the dividend (transfer the amount of stock dividend from R/E to contributed capital) A stock split lowers the market price of a share of stock by replacing existing shares with a greater number of new shares (ie - a three-for-one stock split, a shareholder that owns one share of the stock now owns three shares; in addition, the par value = proportionately reduced
What is the primary reason that a company would declare a stock split?
A stock split is typically declared to reduce the market value of stock by increasing the number of shares outstanding on the market; makes the stock more affordable and increases demand for the stock
What are the advantages of a business corporation?
ADVANTAGES: 1. Limited Liability: limit an investor's potential liability as an owner of a business venture because corporations are legally separate from their owners and therefore, creditors cannot claim owner's personal assets for the company's debt 2. Transferability: transferring ownership of a corporation is easy; investor simply buys or sells stock to acquire/give up ownership interest 3. Continuity: corporation's life continues when a shareholder dies or sells his/her stock 4. Ability to raise capital: t is generally easier to attract many small investors rather than one or two investors willing to invest large sums of money or assets in a business.
Stated Value of Stock
An arbitrary amount assigned by the board of directors to the stock; it has little relevance to investors and creditors
Par Value of Stock
An arbitrary value that is assigned to a share of stock usually at the time of incorporation; par value (historically) represented the maximum liability of the investor
Issued Stock
Authorized stock that has been sold the public/shareholders
Book Value of Stock
Calculated by dividing total stockholder's equity (assets-liabilities) by the number of shares of stock owned by investors (ie shares of stock outstanding)
What is the difference between contributed capital and retained earnings for a corporation?
Contributed capital is the capital acquired by the corporation from owners of the corporation (ie- sale fo stock to an investor) Retained Earnings is the capital of a corporation that has been generated through the earnings process of a corporation and kept within the corporation (ie - it is not distributed to owners)
Describe a Corporation
Corporations are separate legal entities created by an authority of a state government; paperwork to start a corp. = v. complex; each state has unique and separate laws to establish corporations; most states follow the standard provisions of the Model Business Corporation Act --> corporations = v. heavily regulated, especially when exchanges occur on public markets (ie NY Stock Exchange etc.)
Why is it easier for a corporation to raise large amounts of capital than it is for a partnership
Corporations have millions of owners (shareholders) that are able to pool their resources together through public stock and bond dollars, in turn allowing fo corporations to generate the billions of dollars of capital needed for massive investments Proprietorships/Partnerships are limited to a relatively small number of private owners/amount creditors = willing to lend them = limited by the size of the owner's net worth
Treasury Stock
Previously issued stock that has been repurchased by the corporation
Authorized Shares of Stock
The maximum number of shares of stock that corporations are legally permitted to use
What is the difference between cumulative preferred stock and noncumulative preferred stock?
Cumulative preferred stock is a class of preferred stock referring to that if a corporation is unable to pay the preferred dividend in any year, the dividend is not lost but begins to accumulate; any unpaid portion of past dividends (dividends in arrears) is paid first, before any dividends may be paid on common stock Non-Cumulative Preferred Stock is a class of preferred stock whose unpaid dividend is not carried forward to future years; if dividends are not declared in one year, they are lost
What are the disadvantages of a corporation?
DISADVANTAGES: 1. Regulation: Corporations are considerably more regulated by both state/federal governments than sole proprietorships/partnerships; required to file separate income tax returns and public corporations are required to comply with SEC regulations 2. Double Taxation: refers to the profits of a distributed corporation being taxed twice: once when income = reported on the corporation's income tax return and again when distributions - reported on individual owner's tax returns.
What is the importance of the declaration date, record date, and payment date in conjunction with corporate dividends
Declaration Date: the date the dividend is officially declared by the corporation's board of directors; the company becomes legally obligated to pay the dividend once it has been declared (creates a legal liability) Record Date: establishes the ownership of stock by specific shareholders to whom the dividends will be paid (ie- whoever owns the preferred stock on this date get paid the dividends) Payment Date: the date the dividends are paid to the shareholders
What effect does the purchase of. treasury stock have on the equity of a company?
Decreases total equity by increasing the treasury stock account which is a contra-equity account
How does the term double taxation apply to corporations? Give an example of double taxation.
Double taxation applies to corporations because earnings are taxed both at the corporate level and the shareholder level when earnings are distributed in the form of dividends. For example, assume JCL, Inc. had taxable income of $100,000 and distributed $50,000 of the earnings to the shareholders as dividends. The corporation would pay tax on $100,000 at corporate income tax rates, and the shareholders would pay tax on $50,000 at their individual income tax rates. Consequently, $50,000 of the income from the corporation would be taxed twice.
What is the largest source of financing for most U.S. businesses?
Equity financing (ie the capital acquired from owners) = the largest source of financing for most US businesses
What is meant by equity financing? What is meant by debt financing?
Equity financing refers to capital acquired from owners/the sale of ownership interest to raise funds for business purposes; refers to the issuance of stocks; critical for all profit-oriented businesses VS. Debt Financing: refers to borrowing funds in the form of notes and bonds payable
Describe a Partnership
Partnerships allow persons to share their talents, capital and the risks/rewards of business ownership; require clear agreements about how authority, risks, and profits are shared; hire accountants to maintain CAAP compliancy; minimal regulation --> Partnership agreement: defines responsibilities of each partner and describes how income or losses = divided
What are some reasons that a corporation might not pay dividends?
In deciding whether to declare dividends, the board of directors must consider whether the corporation has sufficient cash to cover operating requirements and meet emergencies. The board may also wish to retain earnings in order to pay dividends in years when cash flows are low. In addition, the board may restrict dividends in order to finance future expansion of the business.
What is limited liability company? Discuss its advantages and disadvantages.
Limited Liability companies are companies that offer many of the benefits of corporate ownership and yet are, in general, taxed as sole proprietorships or partnerships at the owner level (ie - limited liability company does not pay the tax, but the owners must pay the tax of company profits); however, owners have limited personal liability/assets of owners = protected from business creditors
What is the difference between par value stock and stated value stock?
Par value and stated value stock are very similar in meaning because they are both arbitrary values assigned to stock; par value is assigned in the charter at the time of incorporation; state value is determined by the board of directors after incorporation
Legal Capital
Par value multiplied by the number of shares issued; represents the minimum amount o assets that should be maintained as protection to creditors
Discuss the purpose of a partnership agreement. Is such an agreement necessary for partnership formation?
Partnership agreements define the responsibilities of each partner and describes how income or losses will be divided. In order to form a partnership, there must be some type of agreement. It can simply be the agreement between parties to perform certain duties/make certain contributions of resources/services. A written agreement is NOT required for legal purposes, but reduces the risk of misunderstandings.
What are the similarities and differences in the equity structure of sole proprietorships, a partnership, and a corporation.
Proprietorships and Partnerships - owner contributions and retained earnings are combined in a single "capital" account for financial statement reporting; capital acquisitions are additions to the capital account of the owners or partners; earnings of the business are additions (losses = the reductions) to the capital account; distributions = withdrawals = reductions of the capital account Corporations: have much more complex capital structures; maintain separate accounts for contributed capital and retained earnings
Describe a Sole Proprietorship.
Sole proprietorships are owned by a single individual who is responsible for making business and profit distribution decisions; usually only requires a business license from local government authorities (ie - no legal ownership agreement requirement); have very minimal regulation
What is the function of the stock certificates?
Stock certificates are evidence of ownership in a corporation
Outstanding Stock
Stock owned by investors outside the corporation; equals the total issued stock minus treasury stock; stock that has been issued and not repurchased by a company
What is no-par stock?
Stock where a par value has not been established by the corporation; it may have a stated value (if it does than the issuance of stock = recorded the same way as par-value stock) If the stock has neither a par nor a stated value, the entire issuance amount is assigned to the capital stock account
What is the purpose of the articles of incorporation? What information do they provide?
The Articles of Incorporation constitute a legal document that is filed with the appropriate state agency requesting the official formation of a corporation. The information they provide includes the following: -1. the corporation's name/proposed date of incorporation -2. the purpose of the corp. -3. location of expected business + life expectancy (can be defined as perpetual or endless) -4. provisions 4 capital stock -5. names/addresses of the members of the 1st board of directors
What prompted Congress to pass the Securities Act of 1933 and the Securities Exchange Act of 1934? What is the purpose of these laws?
The Stock Market Crash of 1929/ Great Depression prompted the passing of the following two acts: 1. Securities Act of 1933 2. Securities Exchange Act of 1934 - created the Securities and Exchange Commission (SEC) to enforce securities laws --> These acts regulate the issuing of stock and govern exchanges of publicly issued stock.
Market Value of Stock
The price an investor must pay to purchase a share of stock; sales price may be more or less than the par value
When a company appropriates retained earnings does the company set aside cash for specific use?
When retained earnings are appropriated, an equal amount of cash is not necessarily set aside. However, retained earnings that are appropriated are not available to be paid out as dividends; appropriation refers to a retained earnings restriction often placed by a board of directors to limit the amount of retained earnings available to distribute as retained earnings
What is a widely held corporation? What is a closely held corporation?
Widely held company: one in which stock is held by a large number of investors/stockholders; controlled with smaller percentages of ownership than closely (consider a company where no existing investor owns more than 1% of stock, a new investor who acquires 5% interest would immediately become the largest shareholder and likely be able to influence board decisions significantly) Closely held corporation: one in which stock ownership is concentrated in the hands of a few persons; harder for investors to control the company (ie if one shareholder owns 51% and the other holds 49%, the investor owning more percentages does not possess that much more sway than the other investor)
Dividends
distributions of corporate profits to the shareholders
