Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
11-1


11

Corporations: Organization, Stock Transactions, and
Stockholders’ Equity

Learning Objectives

11-2

1

Discuss the major characteristics of a corporation.

2

Explain how to account for the issuance of common, preferred, and treasury stock.

3

Explain how to account for cash dividends, stock dividends, and stock splits.

4

Discuss how stockholders’ equity is reported and analyzed.

LEARNING

1

OBJECTIVE

Discuss the major characteristics of a corporation.

An entity separate and distinct from its owners.

Classified by Purpose

11-3

Classified by Ownership



Not-for-Profit



Publicly held



For Profit




Privately held

►

Salvation Army

►

McDonald’s

►

American Cancer Society

►

Nike

►

Cargill Inc.

Alternative
Alternative Terminology
Terminology

►


PepsiCo

►

Google

Privately
Privately held
held corporations
corporations
are
are also
alsoreferred
referred to
to as
as
closely
closely held
held corporations.
corporations.

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

11-4




Separate Legal Existence



Limited Liability of Stockholders



Transferable Ownership Rights
Advantages



Ability to Acquire Capital



Continuous Life



Corporate Management



Government Regulations




Additional Taxes

Disadvantages

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

Corporation acts under its own name

11-5



Separate Legal Existence

rather than in the name of its



Limited Liability of Stockholders

stockholders.




Transferable Ownership Rights



Ability to Acquire Capital



Continuous Life



Corporate Management



Government Regulations



Additional Taxes

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

11-6




Separate Legal Existence



Limited Liability of Stockholders



Transferable Ownership Rights



Ability to Acquire Capital



Continuous Life



Corporate Management



Government Regulations




Additional Taxes

Limited to their investment.

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

11-7



Separate Legal Existence



Limited Liability of Stockholders



Transferable Ownership Rights



Ability to Acquire Capital




Continuous Life



Corporate Management



Government Regulations



Additional Taxes

Shareholders may sell their stock.

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

11-8



Separate Legal Existence




Limited Liability of Stockholders



Transferable Ownership Rights

Corporation can obtain capital



Ability to Acquire Capital

through the issuance of stock.



Continuous Life



Corporate Management



Government Regulations




Additional Taxes

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

11-9



Separate Legal Existence



Limited Liability of Stockholders



Transferable Ownership Rights

Continuance as a going concern is



Ability to Acquire Capital


not affected by the withdrawal,
death, or incapacity of a stockholder,



Continuous Life



Corporate Management



Government Regulations



Additional Taxes

employee, or officer.

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and
partnerships.

11-10




Separate Legal Existence



Limited Liability of Stockholders



Transferable Ownership Rights



Ability to Acquire Capital



Continuous Life



Corporate Management



Government Regulations




Additional Taxes

Separation of ownership and
management often reduces an
owner’s ability to actively manage
the company.

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.

11-11



Separate Legal Existence



Limited Liability of Stockholders



Transferable Ownership Rights




Ability to Acquire Capital



Continuous Life



Corporate Management



Government Regulations



Additional Taxes

LO 1


Characteristics of a Corporation

Characteristics that distinguish corporations from proprietorships and partnerships.



Separate Legal Existence




Limited Liability of Stockholders



Transferable Ownership Rights



Ability to Acquire Capital



11-12

Continuous Life



Corporate Management



Government Regulations



Additional Taxes


Corporations pay income taxes as a
separate legal entity and in addition,
stockholders pay taxes on cash
dividends.

LO 1


Characteristics of a Corporation

Stockholders

Illustration 11-1
Corporation organization chart

Chairman and
Board of
Directors

President and
Chief Executive
Officer

General
Counsel/
Secretary

Vice President
Marketing


Treasurer

11-13

Vice President
Finance/Chief
Financial Officer

Vice President
Operations

Vice President
Human
Resources

Controller

LO 1


Forming a Corporation

Initial Steps:



File application with the Secretary of State.




State grants charter.



Corporation develops by-laws.

Companies generally incorporate in a state whose laws are favorable to the corporate form of business
(Delaware, New Jersey).
Corporations engaged in interstate commerce must obtain a license from each state in which they do
business.

11-14

LO 1


Stockholder Rights

1.

Vote in election of board of directors and on actions that
require stockholder approval.

2.

Share the corporate earnings through receipt of dividends.

Illustration 11-3
Ownership rights of
stockholders


11-15

LO 1


Stockholder Rights

3.

Keep the same percentage ownership when new shares of stock are issued (preemptive right).

* A number of companies have eliminated the preemptive right.

Illustration 11-3
Ownership rights of
stockholders

11-16

LO 1


Stockholder Rights

4.

Share in assets upon liquidation in proportion to their holdings. This is called a residual claim.

Illustration 11-3

Ownership rights of
stockholders

11-17

LO 1


Stock Issue Considerations

When a corporation decides to issue stock, it must resolve a number of basic questions:

11-18

1.

How many shares should it authorize for sale?

2.

How should it issue the stock?

3.

What value should the corporation assign to the stock?

LO 1


Stock Issue Considerations


AUTHORIZED STOCK

11-19



Charter indicates the amount of stock that a corporation is authorized to sell.



Number of authorized shares is often reported in the stockholders’ equity section.



No formal accounting entry.

LO 1


Stock Issue Considerations
Prenumbered

Shares

Illustration 11-4

Name of corporation

Stockholder’s name


Signature of corporate official

11-20

LO 1


Stock Issue Considerations

ISSUANCE OF STOCK



Companies issue common stock directly to investors or indirectly through an investment banking
firm.



11-21

Factors in setting price for a new issue of stock:

1.

Company’s anticipated future earnings.

2.

Expected dividend rate per share.


3.

Current financial position.

4.

Current state of the economy.

5.

Current state of the securities market.

LO 1


Stock Issue Considerations

MARKET PRICE OF STOCK

11-22



Stock of publicly held companies is traded on organized exchanges.



Interaction between buyers and sellers determines the prices per share.




Prices tend to follow the trend of a company’s earnings and dividends.



Factors beyond a company’s control may cause day-to-day fluctuations in market prices.

LO 1


ANATOMY OF A FRAUD
The president, chief operating officer, and chief financial officer of SafeNet, a software encryption company, were each awarded employee stock
options by the company’s board of directors as part of their compensation package. Stock options enable an employee to buy a company’s stock
sometime in the future at the price that existed when the stock option was awarded. For example, suppose that you received stock options today,
when the stock price of your company was $30. Three years later, if the stock price rose to $100, you could “exercise” your options and buy the
stock for $30 per share, thereby making $70 per share. After being awarded their stock options, the three employees changed the award dates in
the company’s records to dates in the past, when the company’s stock was trading at historical lows. For example, using the previous example, they
would choose a past date when the stock was selling for $10 per share, rather than the $30 price on the actual award date. In our example, this
would increase the profit from exercising the options to $90 per share.

Total take: $1.7 million
THE MISSING CONTROL
Independent internal verification. The company’s board of directors should have ensured that the awards were properly administered. For
example, the date on the minutes from the board meeting should be compared to the dates that were recorded for the awards. The dates should
again be confirmed upon exercise.

11-23

LO 1



Stock Issue Considerations

PAR AND NO-PAR VALUE STOCK



Years ago, par value determined the legal capital per share that a company must retain in the
business for the protection of corporate creditors.

11-24



Today many states do not require a par value.



No-par value stock is fairly common today.



In many states, the board of directors assigns a stated value to no-par shares.

LO 1


Stock Issue Considerations


Question
Which of these statements is false?

11-25

a.

Ownership of common stock gives the owner a voting right.

b.

The stockholders’ equity section begins with paid-in capital.

c.

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

d.

Legal capital is intended to protect stockholders.

LO 1