Chapter 11 Flashcards
A corporation has most of the ____________________
rights and privileges of a person
Corporation
A company organized as a seperate legal entity, with most of the rights and privileges of a person
Two common classifications of corporations include:
By purpose
By ownership
Publicly held corporation
A corporation that may have thousands of stockholders and whose stock is traded on a national securities market
Privately held corporation
A corporation that has only a few stockholders and whose stock is not available for sale to the general public
Seperate Legal Existence
Corporate owners (stockholders) do not bind the corporation unless such owners are agents of the corporation
Controller
Chief accounting officer
Responsibilities:
- Maintain the accounting records
- Maintain an adequate system of internal control
- Prepare financial statements, tax returns, and internal reports
Treasurer
Has custody of the corporation’s funds and is responsible for maintaining the company’s cash position
Managers who are not owners
Often compensated based on the performance of the company
May be tempted to exaggerate company performance by inflating income figures
Taxed twice (double taxation)
Corporate income is taxed once at the corporate level and again at the individual level
Advantages of a Corporation compared to a sole proprietorship and partnership
Seperate legal existence
Limited liability of stockholders
Transferable ownership rights
Ability to acquire capital
Continous life
Corporation management - professional managers
Disadvantages of a corporation compared to a sole proprietorship and partnership
Corporation management - seperation of ownership and management
Government regulations
Additional taxes
S corporation
Legal treatment as a corporation but tax treatment as a partnership
Charter
A document that describes a corporatio’s name and purpose, types of stock and number of shares authorized, names of individuals involved in the formation, and number of shares each individual has agreed to purchase
By-laws
Establish the internal rules and procedures for conducting the affairs of the corporation
Corporatioins engaged in interstate commerce
Must obtain a liscence
Common stock
When a corporation has only one class of stock, it is identified as common stock
Stock certificate
Proof of stock ownership is evidenced by a printed or engraved from
Preemptive right
Stockholders right to keep the same percentage ownership when new shares of stock are issued
Residual claim
Stockholders right to share in assets upon liquidation in proportion to their holdings
Authorized stock
The amount of stock that a corporation is authorized to sell as indicated in its charter
Authorization of stock does not ______________________
result in a formal accounting entry
U.S and U.K corporations
financed through shareholders and bondholders
Germany, France, and Japan corporations
Acquire financing mostly from large banks or other financial institutions
Shareholders less important
Issue stock directly
issued directly to investors
Issue stock indirectly
issue stock to an investment banking firm that specializes in bringing securities to the attention of prospective investors
Par value stock
Capital stock that has been assigned a value per share in the corporate charter
Legal capital
The amount of capital that must be retained in the business for the protection of corporate creditors
No-par value stock
Capital stock that has not been assigned a value in the corporate charter
Stated value
The amount per share assigned by the board of directors to no-par stock
Paid-in capital
The amount stockholders paid to the corporation in exchange for shares of ownership
The stockholders’ equity section of a corporation’s balance sheet includes:
- Paid-in (contributed) capital
- Retained earings (earned capital)
Journal entry for issuance of 1,000 shares of $1 par value common stock at par for cash
Cash 1,000
Common stock 1,000
Treasury Stock
A corporation’s own stock that has been reacquired by the corporation and is being held for future use
Reasons to acquire Treasury stock
- To have additonal shares available for use in acquiring other companies
- To reduce the number of shares outstanding and thereby increase earnings per share
p. 580
The purchase of treasury stock is generally accounted for by the ___________
cost method
Mead corporations purchases 4,000 shares of its stock at $8 per share
Journal entry
Dr. Treasury Stock 32,000
Cr. Cash 32,000
Outstanding stock
The number of shares of issued stock that are being held by stockholders
Treasury Stock is what?
A contra stockholders’ equity account
Preferred stock
Capital stock that has contractual preferences over common stock in certain areas
Preferred stockholders have what right?
The right to share in the distribution of corporate income before common stockholders
*receive dividends first
Cumulative dividend
A feature of preferred stock entitling the stockholder to receive current and unpaid prior-year dividends before common stockholders receive any dividends
Dividends in arrears
Preferred dividends that were supposed to be declared but were not declared during a given period
Dividend
A distribution by a corporation to its stockholders on a pro rata (proportional to ownership) basis
Dividends are generally reported ______________
quarterly as a dollar amount per share
Cash dividend
A pro rata (proportional to ownership) distribution of cash to stockholders
Declaration date
The date the board of directors formally authorizes the dividend and announces it to the public
Journal entry on declaration date
Dr. Cash Dividends XXX
Cr. Dividends Payable XXX
Record date
Company determines ownership of the outstanding shares for dividend purposes
*No entry required for the record date*
Payment date
The date cash dividend payments are made to stockholders
Journal entry on payment date
Dr. Dividends Payable XXX
Cr. Cash XXX
Cumulative effect of the declaration and payment on a cash dividend:
Decrease Stockholder’s equity
Decrease Total Assets
stock dividend
A pro rata (proportional to ownership) distribution of the corporation’s own stock to stockholders
A stock dividend results in ___________________
a decrease in retained earnings
and an increase in paid-in capital
*DOES NOT DECREASE STOCKHOLDERS EQUITY OF TOTAL ASSETS*
small stock dividend
less than 20-25% of the corporation’s issued stock
use fair value per share - becayse ut wukk gave kuttke effect on the market price of the shares previously outstanding
large stock dividend
greater than 20-25% of the corporations stock
use par or stated value per share
Another name for stock dividend
capitalizing retained earnings
Stock dividends effect on stockholder’s equity
They change the composition of stockholder’s equity because they transfer a portion of retained earnings to paid-in capital
TOTAL STOCKHOLDERS EQUITY REMAINS THE SAME
Number of shares outstanding increases though
Stock split
The issuance of additional shares of stock to stockholders accompanied by a reduction in the par or stated value per share
Stock split effect on balances in stockholder’s equity
No effect
Total paid-in capital effects
Stock dividend = increase
Stock split = no change
Total retained earnings effects
Stock dividend = decrease
stock split = no change
Total par value (common stock) effects
Stock dividend = increase
stock split = no change
Par value per share effects
Stock dividend = no change
stock split = decrease
Retained earnings
Net income that a company retains in the business
Deficit
A debit balance in retained earnings
Retained earnings restrictions
Circumstances that make a portion of retained earnings currently unavailable for dividends
Three causes:
- Legal
- Contractual
- Voluntary
Capital stock includes:
Preferred stock & Common Stock
Additional paid-in capital includes
The excess of amounts paidin over par or stated value
Payout Ratio =
Cash Dividends Declared on Common Stock
Net Income
*Measures the percentage of earnings a company distributes in the form of cash dividends to common stockholders*
Low payout ratios
Companies that have high growth rates because they reinvest most of their net income in the business instead of paying high dividends
payout ratio isnt necessarily bad news
*However, low dividend payments or a cut in dividend payments, might signal that a company has liquidity or solvency problems and is trying to conserve cash
*INVESTIGATE REASON OF LOW DIVIDEND PAYMENTS
Return on common stockholders’ equity
Net income - Preferred Stock Dividends
Average Common Stockholders’ Equity
*Profitability measure
**shows how many dollars of net income a company earned for each dollar of common stockholders’ equity
***from common stockholders’ viewpoint
Bond advantages relative to common stock
- Stockholder control is not affected - bondholders do not have voting rights, so stockholders (current owners) retain full control of company
- Tax xavings result - bond interest is deductible for tax purposes; dividneds on stock are not
- Return on common stockholders’ equity may be higher - although bond interest expense reduces net income, return on common stockholders’ equity is often higher under bond financing because no additional shares of common stock are issued
If a company wants to increase its return on common stockholders’ equity, ____________________________
It can either increase its return on assets or increase its reliance on debt financing
In general, as long as the return on assets rate exceeds the rate paid on debt, __________________________
a company will increase the return on common stockholders’ equity by the use of debt
Major disadvantage of debt
debt reduces solvency
Journal entry for stock dividend on declaration date
Dr. Stock Dividends XXX
Cr. Common Stock Dividends Distributable XXX
Cr. Paid-in Capital in Excess of Par Value XXX
Journal entry when issue stock dividend
Dr. Common Stock Dividends Distributable XXX
Cr. Common Stock XXX
When issuing bonds instead of stock:
Income before taxes: lower
Income tax expense: lower
Net income: lower
Common Stockholders’ Equity: lower
Return on common stockholders’ equity: higher
