CHAPTER 4

Accounting for Corporation

By: Negalign Nigatu (Ass. professor in accounting and finance

 Learning Objective
1. Discuss the major characteristics of a corporation.
2. Explain how to account for the issuance of common and
preferred stock.
3. Explain how to account for treasury stock.
4. Prepare a stockholders’ equity section.
 Characteristics of a corporation
The important of these characteristics are;
1. Separate Legal Existence: As an entity separate and distinct from its
owners, the corporation acts under its own name rather than in the name
of its stockholders.
2. Limited Liability of Stockholders: The liability of stockholders is
normally limited to their investment in the corporation.
3. Transferable Ownership Rights
4. Ability To Acquire Capital: It is relatively easy for a corporation to
obtain capital through the issuance of stock.
5. Continuous Life
6. Corporation Management: they manage the corporation indirectly
through a board of directors they elect
7. Government Regulations: A corporation is subject to numerous state
and federal regulations.
8. Additional Taxes: Corporations, on the other hand, must pay federal and
state income taxes as a separate legal entity.
Forming a Corporation
A corporation is formed by grant of a state charter.

Advantages and disadvantages of a corporation

 Stockholder Rights
 When chartered, the corporation may begin selling shares of stock. When a
corporation has only one class of stock, it is common stock.
 The major rights that accompany ownership of a share of stock are as
follows:
1. The rights to vote: Vote in election of board of directors at annual
meeting and vote on actions that require stockholder approval.
2. The right to share in distribution of earning: Share the corporate earnings
through receipt of dividends.
3. Preemptive right: Keep the same percentage ownership when new shares
of stock are issued
4. The right to share in assets on liquidation: Share in assets upon
liquidation in proportion to their holdings.

 To appeal to a broader investment market, a corporation may issue one or

more classes of stock with various preference rights.
 A common example of such a right is the preference to dividends. Such a
stock is generally called a preferred stock.
Stockholders’ Equity
The owners’ equity in a corporation is commonly called stockholders’
equity, share holders’ equity, shareholders’ investment, or capital.
In a corporation balance sheet, the Stockholders’ Equity section reports the
amount of each of the two main sources of stockholders’ equity.
The first source is capital contributed to the corporation by the stockholders
and others, called paid-in capital or contributed capital.
The second source is net income retained in the business, called retained
earnings
The paid-in capital contributed by the stockholders is recorded in separate
accounts for each class of stock.
If there is only one class of stock, the account is en titled Common Stock
or Capital Stock.
Retained earnings are generated from operations.
Net income increases retained earnings, while dividends decrease retained
earnings.
Thus, retained earnings represents a corporation’s accumulated net income
that has not been distributed to stockholders as dividends.
 Stock
The number of shares of stock that a corporation is
authorized to issue is stated in its charter.
The term issued refers to the shares issued to the
stockholders
The stock remaining in the hands of stockholders is then called
outstanding stock.
 Stock Issue Considerations
When a corporation decides to issue stock, it must resolve a
number of basic questions:
How many shares should it authorize for sale?
How should it issue the stock?
What value should the corporation assign to the stock?
AUTHORIZED STOCK
The charter indicates the amount of stock that a corporation
is authorized to sell.
The total amount of authorized stock at the time of
incorporation normally anticipates both initial and subsequent
capital needs.
As a result, the number of shares authorized generally
exceeds the number initially sold. If it sells all authorized
stock, a corporation must obtain consent of the state to
amend its charter before it can issue additional shares.
ISSUANCE OF STOCK

A corporation can issue common stock directly to investors.

Alternatively, it can issue the stock indirectly through an
investment banking firm that specializes in bringing securities to
the attention of prospective investors.
Direct issue is typical in closely held companies.
Indirect issue is customary for a publicly held corporation.
 How does a corporation set the price for a new issue of stock?
 Among the factors to be considered are
1. the company’s anticipated future earnings,
2. its expected dividend rate per share,
3. its current financial position,
4. the current state of the economy, and
5. the current state of the securities market.
MARKET PRICE OF STOCK

The stock of publicly held companies is traded on organized

exchanges.
The interaction between buyers and sellers determines the
prices per share.
In general, the prices set by the marketplace tend to follow the
trend of a company’s earnings and dividends.
The trading of capital stock on securities exchanges involves
the transfer of already issued shares from an existing
stockholder to another investor.
These transactions have no impact on a corporation’s
stockholders’ equity
PAR AND NO-PAR VALUE STOCKS

a. Par value stock:

Shares of stock are often assigned a monetary amount, called
par.
Corporations may issue stock certificates to stockholders to
document their ownership.
Printed on a stock certificate is the par value of the stock,
the name of the stockholder, and the number of shares owned.
is capital stock to which the charter has assigned a value per
share.
Thus, in the past, most conditions required the corporation to
sell its shares at par or above.
b. No-par value stock:
Stock may also be issued without par, in which case it is
called no-par stock.
Some states require the board of directors to assign a
stated value to no-par stock.
is capital stock to which the charter has not assigned a
value.
No-par value stock is fairly common today
 Account for the Issuance of Common
Stock.
The primary objectives in accounting for the issuance of
common stock are
1. to identify the specific sources of paid-in capital, and
2. to maintain the distinction between paid-in capital and
retained earnings.
The issuance of common stock affects only paid-in capital
accounts.
Issuing Par Value Common Stock for Cash
 As discussed earlier, par value does not indicate a stock’s market price.
 Therefore, the cash proceeds from issuing par value stock may be equal
to, greater than, or less than par value.
 When the company records issuance of common stock for cash, it credits
the par value of the shares to Common Stock.
 It also records in a separate paid-in capital account the portion of the
proceeds that is above or below par value.
To illustrate, assume that Hydro-Slide, Inc. issues 1,000 shares of
$1 par value common stock at par for cash. The entry to record
this transaction is:

Now assume that Hydro-Slide issues an additional 1,000 shares of the $1 par
value common stock for cash at $5 per share. The amount received above
the par value, in this case $4 ($5 - $1), is credited to Paid-in Capital in Excess
of Par— Common Stock. The entry is:
Issuing No-Par Common Stock for Cash

 When no-par common stock has a stated value, the entries are similar to
those illustrated for par value stock.
 The corporation credits the stated value to Common Stock.
 Also, when the selling price of no-par stock exceeds stated value, the
corporation credits the excess to Paid-in Capital in Excess of Stated Value—
Common Stock.

Example
assume that instead of $1 par value stock, Hydro-Slide, Inc. has $5 stated
value no-par stock and the company issues 5,000 shares at $8 per share for
cash. The entry is as follows.
Accounting for Preferred Stock
Demand to a larger segment of potential investors, a
corporation may issue an additional class of stock, called
preferred stock.
Preferred stock has contractual provisions that give it some
preference or priority over common stock.
Typically, preferred stockholders have a priority as to;
1. distributions of earnings (dividends) and
2. assets in the event of liquidation.
However, they generally do not have voting rights.
Like common stock, corporations may issue preferred stock
for cash or for noncash assets.
The entries for these transactions are similar to the entries
for common stock.
When a corporation has more than one class of stock,
each paid-in capital account title should identify the stock to
which it relates.
A company might have the following accounts:
 Preferred Stock,
 Common Stock,
 Paid-in Capital in Excess of Par—Preferred Stock, and
 Paid-in Capital in Excess of Par— Common Stock.
For example, if Stine Corporation issues 10,000 shares of $10
par value preferred stock for $12 cash per share, the entry to
record the issuance is as follows.
Accounting for Treasury Stock
A corporation may buy its own stock to provide shares for
resale to employees, for reissuing as a bonus to employees, or
for supporting the market price of the stock.
Such stock that a corporation has once issued and then
reacquires is called treasury stock.
Treasury stock is a corporation’s own stock that it has issued
and subsequently reacquired from shareholders but not
retired.
A corporation may acquire treasury stock for various
reasons:
1. To reissue the shares to officers and employees under
bonus and stock compensation plans.
2. To increase trading of the company’s stock in the
securities market
3. To have additional shares available for use in the
acquisition of other companies.
4. To reduce the number of shares outstanding and
thereby increase earnings per share.
Another infrequent reason for purchasing shares is that
management may want to eliminate hostile shareholders by
buying them out.
Purchase of Treasury Stock

Companies generally account for treasury stock by the cost

method.
This method uses the cost of the shares purchased to value the
treasury stock.
Under the cost method, the company debits Treasury Stock
for the price paid to reacquire the shares.
When the company disposes of the shares, it credits to
Treasury Stock.
Disposal of Treasury Stock

The accounting for its sale differs when treasury stock is sold
above cost than when it is sold below cost.

Sale of Treasury Stock Above Cost

 If the selling price of the treasury shares is equal to their cost,

the company records the sale of the shares by a debit to Cash
and a credit to Treasury Stock.
 When the selling price of the shares is greater than their cost,
the company credits the difference to Paid-in Capital from
Treasury Stock.
Example
To illustrate, assume that on July 1, Mead, Inc. sells for $10 per share 1,000 of
the 4,000 shares of its treasury stock previously acquired at $8 per share. The
entry is as follows.

 Mead does not record a $2,000 gain on sale of treasury stock for two
reasons.
(1) Gains on sales occur when assets are sold, and treasury stock is not an
asset.
(2) A corporation does not realize a gain or suffer a loss from stock
transactions with its own stockholders.
SALE OF TREASURY STOCK BELOW COST

 When a company sells treasury stock below its cost, it usually debits to Paid-
in Capital from Treasury Stock the excess of cost over selling price.
 Thus, if Mead, Inc. sells an additional 800 shares of treasury stock on October
1 at $7 per share, it makes the following entry.

Cash = 7*800= 5600

Paid-in capital = (7-8)= 800
Treasury stock = 8*800=6400
 Illustration
Santa Anita Inc. purchases 3,000 shares of its $50 par value
common stock for $180,000 cash on July 1. It will hold the shares
in the treasury until resold. On November 1, the corporation sells
1,000 shares of treasury stock for cash at $70 per share.
Journalize the treasury stock transactions.
 Prepare a stockholders’ equity section
Companies report paid-in capital and retained earnings in the
stockholders’ equity section of the balance sheet.
They identify the specific sources of paid-in capital, using the
following classifications.
1. Capital stock.
This category consists of preferred and common stock.
Preferred stock appears before common stock because of
its preferential rights.
Companies report par value, shares authorized, shares
issued, and shares outstanding for each class of stock.
2. Additional paid-in capital.
This category includes the excess of amounts paid in
over par or stated value and paid-in capital from
treasury stock.
 Illustration
Jennifer Corporation has issued 300,000 shares of $3 par value common
stock. It authorized 600,000 shares. The paid-in capital in excess of par on the
common stock is $380,000. The corporation has reacquired 15,000 shares at
a cost of $50,000 and is currently holding those shares. Treasury stock was
reissued in prior years for $72,000 more than its cost. The corporation also
has 4,000 shares issued and outstanding of 8%, $100 par value preferred
stock. It authorized 10,000 shares. The paid-in capital in excess of par on the
preferred stock is $25,000. Retained earnings is $610,000. Prepare the
stockholders’ equity section of the balance sheet.

Preferred stock = 100*4000 shares = $400,000

Common stock = 3*300,000 shares = $900,000
paid-in capital in excess of par on the common stock = $380,000
paid-in capital in excess of par on the preferred stock = $25,000
paid-in capital from treasure stock = $72,000
Retained earnings = $610,000
Treasure stock at cost = $50,000