REVIEW OF CHAPTER 14  

The Corporate Form of Organization

1.     (S.O. 1)  A corporation is an entity created by law that is separate and distinct from its owners and its continued existence is dependent upon the corporate statutes of the state in which it is incorporated.

2.     The characteristics that distinguish a corporation from proprietorships and partnerships are:

         a.     The corporation has separate legal existence from its owners.

         b.     The stockholders have limited liability.

         c.     Ownership is shown in shares of capital stock, which are transferable units.

         d.     It is relatively easy for a corporation to obtain capital through the issuance of stock.

         e.     The corporation can have a continuous life.

         f.     The management in the corporation's organizational structure is at the discretion of the board of directors who are elected by the stockholders.

         g.     The corporation is subject to numerous government regulations.

         h.     The corporation must pay an income tax on its earnings, and the stockholders are required to pay taxes on the dividends they receive; the result is double taxation.

Forming a Corporation

3.     The formation of a corporation involves (a) filing an application with the Secretary of State, (b) paying an incorporation fee, (c) receiving a charter (articles of incorporation), and (d) developing by-laws.

         a.     Costs incurred in forming a corporation are called organization costs.

         b.     These costs include fees to underwriters, legal fees, state incorporation fees, and promotional expenditures.

         c.     Organization costs are expensed as incurred.

Ownership Rights of Stockholders

4.     When chartered, the corporation may begin selling ownership rights in the form of shares of stock.  Each share of common stock gives the stockholder the following ownership rights:

         a.     To vote for the board of directors and in corporate actions that require stockholder approval.

         b.     To share in corporate earnings through the receipt of dividends.

         c.     To maintain the same percentage ownership when additional shares of common stock are issued (preemptive right).

         d.     To share in assets upon liquidation (residual claim).

Stock Issue Considerations

5.     Authorized stock is the amount of stock a corporation is allowed to sell as indicated by its charter.

         a.     The authorization of capital stock does not result in a formal accounting entry.

         b.     The difference between the shares of stock authorized and the shares issued is the number of unissued shares that can be issued without amending the charter.

6.     A corporation has the choice of issuing common stock directly to investors or indirectly through an investment banking firm (brokerage house).  Direct issue is typical in closely held companies, whereas indirect issue is customary for a publicly held corporation.

7.     Par value stock is capital stock that has been assigned a value per share in the corporate charter.  It represents the legal capital per share that must be retained in the business for the protection of corporate creditors.

8.     No-par stock is capital stock that has not been assigned a value in the corporate charter.  In many states the board of directors can assign a stated value to the shares which becomes the legal capital per share.  When there is no assigned stated value, the entire proceeds are considered to be legal capital.

Corporate Capital

9.     (S.O. 2)  Owner's equity  in a corporation is identified as stockholders' equity, share-holders' equity, or corporate capital.  The stockholders' equity section of a corporation's balance sheet consists of:  (a) paid-in (contributed) capital, and (b) retained earnings (earned capital).

10.     Paid-in capital is the investment of cash and other assets in the corporation by stockholders in exchange for capital stock.

11.     Retained earnings is net income retained in a corporation.

         a.     Net income is recorded in Retained Earnings by a closing entry with a debit to Income Summary and a credit to Retained Earnings.

         b.     Retained earnings (earned capital) is part of the stockholders' equity section of a corporation.

12.     (S.O. 3)  The primary objectives in accounting for the issuance of common stock are to (a) identify the specific sources of paid-in capital and (b) maintain the distinction between paid-in capital and retained earnings.

13.     When par value common stock is issued for cash, the par value of the shares is credited to Common Stock and the portion of the proceeds that is above or below par value is recorded in a separate paid-in capital account.

14.     When no-par common stock has a stated value, the stated value is credited to Common Stock.  When the selling price exceeds the stated value, the excess is credited to Paid-in Capital in Excess of Stated Value.  When no-par stock does not have a stated value, the entire proceeds are credited to Common Stock.

Common Stock for Services or Non-Cash Assets

15.     When common stock is issued for services or non-cash assets, cost is either the fair market value of the consideration given up or the consideration received, whichever is more clearly determinable.

Treasury Stock

16.     (S.O. 4)  Treasury stock is a corporation's own stock that has been issued, fully paid for, and reacquired but not retired.

         a.     Under the cost method, Treasury Stock is debited at the price paid for the shares and the same amount is credited to Treasury Stock when the shares are reissued.

         b.     When the Treasury Stock is resold and the selling price of the shares is greater than cost, the difference is credited to Paid-in Capital from Treasury Stock.

         c.     When the selling price is less than cost, the excess of cost over selling price is usually debited to Paid-in Capital From Treasury Stock.  When there is no remaining balance in Paid-in Capital From Treasury Stock, the remainder is debited to Retained Earnings.

Preferred Stock

17.     (S.O. 5)  Preferred stock has contractual claims that give it priority over common stock.  Preferred stockholders usually have a preference to dividends and assets in the event of liquidation.  However, they usually do not have voting rights.

18.     Preferred stock should be identified separately from other stock (e.g., Preferred Stock, Paid-in Capital in Excess of Par Value Preferred Stock).  Preferred stock is shown first in the stockholders' equity section.

Cumulative Dividend

19.     A cumulative dividend provides that preferred stockholders must be paid both current and prior year dividends before common stockholders receive any dividends.

         a.     Preferred dividends not declared in a given period are called dividends in arrears.

         b.     Dividends in arrears are not considered a liability, but the amount of the dividends in arrears should be disclosed in the notes to the financial statements.

Convertible Preferred Stock

20.     Convertible preferred stock provides for the exchange of preferred stock into common stock at a specified ratio.  In recording the conversion, the amount paid-in on the preferred stock is transferred to appropriate common stock accounts (Common Stock and Paid-in Capital in Excess of Par Value).

Callable Preferred Stock

21.     Callable preferred stock grants the issuing corporation the right to purchase the stock from stockholders at specified future dates and prices.

Stockholders' Equity Presentation

22.     (S.O. 6)  In the stockholders' equity section, paid-in capital and retained earnings are reported and the specific sources of paid-in capital are identified.  Within paid-in capital, two classifications are recognized.

         a.     Capital stock, which consists of preferred and common stock.  Preferred stock is shown before common stock because of its preferential rights.  Information as to the par value, shares authorized, shares issued, and shares outstanding is reported for each class of stock.

         b.     Additional paid-in capital, which includes the excess of amounts paid in over par or stated value and paid-in capital from treasury stock.

Book Value Per Share

23.     (S.O. 7)  Book value per share represents the equity a common stockholder has in the net assets  of the corporation from owning one share of stock.

         a.     The formula for computing book value per share when a company has only one class of stock outstanding is:

         b.     Book value per share is not synonymous with the value of the stock in liquidation.