Accounting Principles II – Corporations - Quick Guides

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Study GuideAccounting PrinciplesII–Corporations1.Characteristics of a CorporationWhat Is a Corporation?Acorporationis alegal entity, which means it exists separately from its owners. The owners of acorporation are calledstockholders(orshareholdersin some states).Because a corporation is considered a separate “person” under the law, it:•Has many of the rights and responsibilities of a real person•Can own property, enter contracts, borrow money, and pay taxes•Cannot vote in public elections or hold public officeCorporations can be:•For-profitornonprofit•Publicly heldorprivately held1.Public vs. PrivateCorporations•Public corporationssell stock on a stock exchange. They may havethousands or evenmillions of stockholders.•Privately held corporationsdo not trade stock on an exchange and usually havea smallnumber of stockholders.2.Forming a CorporationTo legally become a corporation, a business must:1.File an application with the state2.Submitarticles of incorporation(also called a charter)

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Study Guide3.Pay an incorporation fee4.Receive approval from the stateAfter approval, the corporation must create itsbylaws, which describe how the company will begoverned.3.Organization CostsCosts related to forming a corporation—such as:•Legal fees•Incorporation fees•Underwriters’ fees for issuing stock or bondsare recorded as anintangibleassetandamortized over time, for a period not exceeding40 years.4.Ownership and Stockholders’ RightsOwnership in a corporation is represented bystock certificates. These certificates show how manyshares a stockholder owns.Stockholders have theright to:•Votefor the Board of Directors and other major issues•Receive dividends, if approved by the Board•Exercisepre-emptive rights, allowing them to buy additional shares to maintain theirownership percentage•Share in the corporation’s assets(up to their investment) if the company is liquidated5.Key Characteristics of a Corporation1.Unlimited LifeA corporation hascontinuous existence.

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Study GuideThe death of a stockholder, sale of stock, or loss of an employee doesnotaffect the corporation’sability to continue operating.The corporation’s life may be limited by its charter, but it can continue if the charter is extended.2.Limited LiabilityOne of the biggest advantages of a corporation islimited liability.•Stockholders are only responsible for debtsup to the amount they invested•Theirpersonal assets are protected•Creditors can only claimcorporate assets, not stockholders’ personal property3.Separate Legal EntityBecause a corporation is legally separate from its owners, it:•Conducts business in its own name•Can sue or be sued•Pays its own income taxesStockholders arenot agentsof the corporation unless they are also employees or officiallydesignated as agents.4.Ease of Transferring OwnershipOwnership in a corporation is easy to transfer, especially for public companies.•Stockholders can sell all or part of their shares at any time•No approval from other stockholders is required•Buyers do not need approval from the corporationAfter the initial stock sale, the corporation is involved only as arecord keeperof share ownership.Privately held corporations may place some restrictions on stock transfers.

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Study Guide5.Professional ManagementStockholders do not need to manage the business themselves.•Stockholders elect theBoard of Directors•The Board hiresprofessional managers•Managers handle daily operationsThis allows investors to earn returns without being involved in day-to-day decision-making.6.Ease of Capital AcquisitionCorporations can raise largeamounts of money by:•Issuingstock•IssuingbondsLimited liability and easy ownership transfer make investing attractive, while the size and reputation ofa corporation make borrowing easier.7.Government RegulationsCorporations are subject tomore regulation than sole proprietorships and partnerships.•State lawsregulate stock issuance and dividend payments•Federal securities lawsgovern the sale of stock•Public companiesmust file financial statements and disclosures with the Securities andExchange Commission (SEC)Some industries—such asbanking, financial services, and gaming—are subject to additionalregulation from other government agencies.2.Stock TerminologyBefore learning how to account for stock, it’s important to understand some basic stock terms. Theseideas come up often in accounting, so let’s break them down in a clear and easy way.

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Study Guide1.Authorized StockAuthorized stock is themaximum number of sharesa corporation is allowed to sell.This number is listed in the company’sarticles of incorporation.If the company wants to issue more shares than this amount, it must first get approval from itsstockholders.2.Issued StockIssued stock refers to the shares that the corporation hasalready given to stockholders.These shares are exchanged for things likecash, property, or services.3.Outstanding StockOutstanding stock is issued stock that isstill owned by stockholders.These shares havenotbeen bought back by the corporation.4.Treasury StockTreasury stock is stock that wasissued before but later repurchasedby the corporation.These shares are no longer held by investors.1.Market ValueMarket value is thecurrent price of a stockin the marketplace.It is determined bybuyers and sellersand applies only topublicly traded companies.2.Par ValuePar value is a small value assigned to each share of stock in thearticles of incorporation.This amount appears on thestock certificate.

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Study GuideIn some states, the total par value of all outstanding shares is calledlegal capital.Legal capital must stay in the business andcannot be paid out as dividends.3.Contributed Capital (Paid-In Capital)Contributed capital is thevalue a corporation receives when it issues stock.It includes:•Thepar value, and•Any amount receivedabove par valueThis is also known aspaid-in capital.5.No-Par Value StockNo-par value stock doesnothave a par value listed on it.Instead, theBoard of Directorsmay assign a value to the stock.6.Stated ValueStated value is the value assigned by theBoard of Directorstono-par value stock.It serves a similar purpose to par value.5.Common StockCommon stock is themost common type of stockissued by corporations.Common stockholders usually have the right to:•Voteon company matters•Receivedividends after preferred stockholders•Receive any remaining investmentafter creditors and preferred stockholdersare paid ifthe company is liquidatedCommon stock may have:

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Study Guide•Apar value, or•No par value, with or without a stated value6.Preferred StockPreferred stock gives stockholders certainpreferences over common stockholders.Preferred stockholders usually:•Receivedividends first•Get their investment backbefore common stockholdersif the company is liquidatedPreferred stock typicallydoes not include voting rights.1.DividendsDividends arepayments made by a corporation to its stockholders.They can be paid in:•Cash•Other assets•Additional shares of stockStockholders cannot withdraw money whenever they want.Dividends are paidonly if the Board of Directors approves them.2.Stockholders’ EquityOn a corporation’s balance sheet, the owners’ equity section is calledstockholders’ equity.It includes:•Contributed capital, and•Retained earnings

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Study Guide3.Retained EarningsRetained earnings show thetotal net income earned by a corporationsince it began operations,minus dividends paid.Retained earnings:•Increasewith net income•Decreasewith dividends, net losses, and some treasury stock transactionsDuring theclosing process, net income and dividends (if recorded separately) are transferred intoretained earnings.3.Accounting for Stock TransactionsThis section explains how corporations record stock transactions in their accounting records. We’llwalk through each situation step by step and connect the journal entries to what is happening in reallife.1. Issuing Stock for CashCorporations often raise money by selling stock for cash. How the transaction is recorded depends onwhether the stock has apar value,no par value, or ispreferred stock.Issuing Common Stock at Par ValueWhen a company issues common stockat par value, the cash received equals the par value of theshares issued.Example:Big City Dwellers issues5,000 shares of $1 par value common stockat par.•Cash received = 5,000 × $1 =$5,000•Cash increases (debit)•Common Stock increases (credit)This entry records exactly what happened: the companyreceived cash and issued ownership shares.

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Study GuideIssuing Common Stock Above Par ValueSometimes stock sells formore than its par value. When this happens, the extra amount is recordedinAdditional Paid-in Capital.Example:Big City Dwellers sells5,000 shares of $1 par value stock for $5 per share.•Cash received = 5,000 × $5 =$25,000•Par value portion = 5,000 × $1 =$5,000•Extra amount =$20,000How it’s recorded:•Debit Cash for $25,000•Credit Common Stock for $5,000•Credit Additional Paid-in Capital for $20,000

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Study GuideThe company separates the legal par value from the extra amount investors were willing to pay.Issuing No-Par Value StockSome stock does not have a par value.•If theBoard of Directors assigns a stated value, that value istreated like par value.•Ifno stated value is assigned, theentire amount receivedis credited to the CommonStock account.If a company issues both par value and no-par value stock, it must keepseparate Common Stockaccounts.Issuing Preferred StockPreferred stock follows thesame accounting rulesas common stock, but it usesseparateaccounts.Preferred stockholders usually:•Receive dividends first•Get paid before common stockholders if the company liquidates

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