Chapter 9 Notes to Accompany In-Class Lecture

1. Corporation - Characteristics
a. advantages
1. separate legal entity
2. continuous life/transfer of ownership
3. limited liability
b. disadvantages
1. separation of ownership and management
2. double taxation
3. government regulations

2. Organizing a corporation
a. organize the corporation
b. pay fees
c. sign charter
d. file documents with the state
e. agree to bylaws

3. Four basic rights of corporation’s shareholders (owners)

a. vote
b. receive dividends
c. receive share of assets if corporation liquidates
d. maintain proportionate ownership – preemptive right

4. Stockholders’ Equity
a. paid-in capital
b. retained earnings

5. Classes of stock
a. common: basic form, rights of ownership, benefit most if succeeds, risk highest
b. preferred: have preference in receiving dividends/liquidations, hybrid b/w c.s. & debt
6. Stock terminology
a. par value of stock
b. no par stock
c. authorized stock
d. issued stock
e. outstanding stock
f. issue price of stock
g. market price of stock

7. Issue (sale) of stock journal entries

a. Stock sold at par value:
Cash XX
Common (Preferred) Stock
b. Stock sold at a price above par:
Cash XX
Common (Preferred) Stock
Paid-in Capital in Excess of Par
c. No-par stock (or stated value stock) sold:
Cash XX
Common (Preferred) Stock
(# of shares * issue price)
XX (# of shares * par value)
(# of shares * issue price)
XX (# of shares * par value)
XX (“plug” figure)
(# of shares * issue price)
XX (# of shares * issue price)

d. Stock sold for assets other than cash:

Asset XX (market value of the asset)
Common (Preferred) Stock XX (# of shares * par value)
Paid-in Capital in Excess of Par XX (“plug” figure)
8. Preferred Stock
a. follows same pattern as common stock entries
b. preferred stock is credited for shares issued times par value
c. a separate paid-in capital account is used if stock is issued above par

9. Terms: Authorized, Issued, Outstanding

a. authorized: maximum # of shares company can issue as indicated by its charter
b. issued: # of shares company has sold to shareholders
c. outstanding: # of shares currently in shareholders’ possession
-- any difference between issued and outstanding is due to treasury stock

10. Treasury Stock

a. entry to record purchase of treasury stock
Treasury Stock XX (# of shares * cost per share)
Cash XX
b. entry to record the sale of treasury stock above cost
Cash XX (# of shares * sale price)
Treasury Stock (original cost) XX (# of shares * cost per share)
Paid-in Capital from Treasury Stock
Transactions XX (“plug” figure)
c. entry to record the sale of treasury stock below cost
Cash XX
Paid-in Capital from Treasury Stock
Transactions (or Retained Earnings) XX
Treasury Stock (original cost) XX

11. Retained earnings

a. balance = net incomes – net losses – dividends declared
b. Accumulated earnings the company keeps
c. Not a reservoir of cash
d. deficit if debit balance (has a normal credit balance)
e. If retained earnings increases, net income is greater than dividends
f. If retained earnings decreases, net income is less than dividends
12. Dividends – distributions to stockholders
a. three forms
1. cash
2. stock
3. noncash assets
b. company must have enough RE to declare dividend AND enough cash to pay dividend
c. dividend is declared by the Board of Directors
d. dividend date of declaration
Retained Earnings XX
Dividends Payable XX
e. date of record – no entry
f. date of payment
Dividends Payable XX
Cash XX
g. preferred dividends
1. preferred cumulative
i. dividends in arrears
EXAMPLE of Preferred Cumulative Dividends
i. A corporation has 10,000 shares of $100, 8% cumulative preferred stock
outstanding
ii. Also has 80,000 shares of $1 par common stock outstanding
iii. Board of Directors declares dividends as follows:
a. Year 1: $20,000
b. Year 2: $150,000
iv. Solution:
a. Preferred dividend annual: 10,000 shares x $100 par x 8% = $80,000
b. Year 1: $20,000 declared – all goes to preferred but preferred is still
owed $60,000 ($80,000 - $60,000)
c. Year 2: Preferred is owed $80,000 from current year AND $60,000 in
arrears, so preferred will get $140,000 ($80,000 + $60,000);
common stockholders get the remaining $10,000 ($150,000 -
$140,000)
2. preferred noncumulative
3. preferred participating
4. preferred nonparticipating
b. stock dividend
1. small stock dividends
2. large stock dividends
c. noncash assets
13. Stock Splits
14. Stock Value Terms
1. Market value (price one can buy or sell one share of stock for – varies widely)
2. Redemption value (set price company is required to pay to retire preferred stock)
3. Liquidation value (required payment to preferred shareholders if company liquidates)
4. Book value (Common Equity / # of common shares outstanding)

15. Evaluating ratios

a. return on assets
ROA = Net income + Interest expense
Average total assets
b. return on equity
ROE = Net income – Preferred dividends
Average common stockholders’ equity

16. Equity transactions on the cash flow statement

1. all equity transactions are financing activities
2. issuing stock – financing inflow
3. purchase of treasury stock – financing outflow
4. payment of cash dividends – financing outflow