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Proprietorships, Partnerships,
and Corporations
Acct 2210: Chp 11
McGraw-Hill/IrwinMcGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
LO 1
Identify the primary
characteristics of sole
proprietorships, partnerships, and
corporations.11-2
Business Forms • A sole proprietorship is owned by a single
individual.• A partnership is owned by two or more
individuals.– Partnerships require clear agreements about
authority, risks, and the sharing of profits and losses.
• A corporation is a separate legal entitycreated by the authority of a state government.– Each state has separate laws governing
establishing corporations.
11-3
Regulation
Few laws govern the operationsof sole proprietorships and partnerships.
Few laws govern the operationsof sole proprietorships and partnerships.
Corporations are subject to regulations.
Large, publicly traded corporationsare much more heavily regulated thansmaller, closely-held corporations. SEC Acts of 1933 and 1934. Sarbanes-Oxley Act of 2002. Exchange listing requirements.
Corporations are subject to regulations.
Large, publicly traded corporationsare much more heavily regulated thansmaller, closely-held corporations. SEC Acts of 1933 and 1934. Sarbanes-Oxley Act of 2002. Exchange listing requirements.
11-4
Corporate Advantages Separate legal entity Limited liability of stockholders Continuous life Easily transferable ownership rights Ability to raise capital
Corporate Disadvantages Governmental regulation Corporate double taxation
Corporate Advantages Separate legal entity Limited liability of stockholders Continuous life Easily transferable ownership rights Ability to raise capital
Corporate Disadvantages Governmental regulation Corporate double taxation
Comparing Forms of Ownership
11-5
Vice President(Production)
V ice President(M arketing)
V ice President(F inance)
V ice President(Personnel)
President
B oard of D irectorsInternal (m anagers) andExternal (nonm anagers)
S tockholders(O w ners of voting shares)
Elected byshareholders
Appointedby directors
Corporate Management Structure
11-6
Capital Structure in Financial Statements
Sole Proprieterships Partnerships CorporationsOwnership interest
Single capital account for the owner
Capital account for each partner
1. Capital stock consisting of common stock and preferred stock 2. Separate retained earnings account
Distributions Withdrawals Withdrawals Dividends
The ownership interest (equity)in a business is composed of: Owner/investor
contributions. Retained earnings.
The ownership interest (equity)in a business is composed of: Owner/investor
contributions. Retained earnings.
11-7
Explain how different types of capital stock affect financial
statements.
LO 2
11-8
Legal capital is the amount of capital, required by the state of incorporation, that must remain invested in the business.
Par Value
Nominal Amount
Legal Capital
Characteristics of Capital stock
11-9
Some states do notrequire a par value to be stated in the charter.
No-par Stock
Characteristics of Capital Stock
11-10
Par value is an arbitrary amount assigned to each share of stock when it is authorized.
Par value is an arbitrary amount assigned to each share of stock when it is authorized.
Market price is the amount that each share of stock will sell for in the market.
Market price is the amount that each share of stock will sell for in the market.
Characteristics of Capital Stock
11-11
Authorized, Issued, and Outstanding Capital Stock
The maximum number of shares of capital stock that can be sold to the public.
Authorized
Shares
11-12
Authorized, Issued, and Outstanding Capital Stock
Unissued
StockTreasury
Stock
Outstanding
StockIssue
dStock Treasury stock is
issued stock that has been
reacquired by the corporation.
Outstanding stock is issued stock that is
owned by stockholders.
Authorized
Stock
11-13
Common stockholders have the rights to: Buy and sell stock. Share in the distribution of profits. Share in the distribution of assets in
the case of liquidation. Vote on significant matters that affect
the corporate charter. Participate in the election of directors.
Common stockholders have the rights to: Buy and sell stock. Share in the distribution of profits. Share in the distribution of assets in
the case of liquidation. Vote on significant matters that affect
the corporate charter. Participate in the election of directors.
Classes of Stock – Common Stock
11-14
A separate class of stock, typically having priority over common shares in . . .
Dividend distributions. Distribution of assets in case of liquidation.
A separate class of stock, typically having priority over common shares in . . .
Dividend distributions. Distribution of assets in case of liquidation.
Classes of Stock – Preferred Stock
25%
75%
Corporationswith preferredstock
Corporationswithoutpreferred stock
Usually has a stated dividend
rate.
Usually has a stated dividend
rate.
Normally has no voting rights.
Normally has no voting rights.
11-15
NoncumulativeCumulative
Dividends in arrears must be paid before dividends may be paid on common stock.
Dividends in arrears must be paid before dividends may be paid on common stock.
Undeclared dividends from current and prior years do not have to be paid in future years.
Undeclared dividends from current and prior years do not have to be paid in future years.
Most preferred stock is cumulative.Most preferred stock is cumulative.
Preferred Stock Dividends
11-16
Preferred Stock Dividends
Dillion Inc. has the following stock outstanding:– Preferred stock, 4%, $10 par, 10,000 shares
– Common stock, $10 par, 20,000 shares
Dividends have not been paid in two years. In the current year, the board of directors declared dividends of $22,000.
How much will each class of stock receive?
11-17
Total dividend declared 22,000$
Preferred stock (cumulative)Arrearage 1st year ($10 par × 4% × 10,000 shares) 4,000$ 2nd year ($10 par × 4% × 10,000 shares) 4,000 Current Yr. ($10 par × 4% × 10,000 shares) 4,000 12,000
Remainder to common stockholders 10,000$
Preferred Stock Dividends
The distribution depends on whether the preferred stockis cumulative or noncumulative. First, let’s assume thepreferred stock is cumulative.
The distribution depends on whether the preferred stockis cumulative or noncumulative. First, let’s assume thepreferred stock is cumulative.
11-18
Preferred Stock Dividends
Now, let’s assume the preferred stock is noncumulative.Now, let’s assume the preferred stock is noncumulative.
Total dividend declared 22,000$
Preferred stock (noncumulative)Arrearage 1st year $ 0 2nd year 0Current yr. ($10 par × 4% × 10,000 shares) 4,000 4,000
Remainder to common stockholders 18,000$
11-19
Issuing Par Value Stock
Account Title Debit CreditCash 2,200 Common Stock, $10 Par 1,000 Paid-in Capital in Excess of Par, Com. 1,200
Nelson, Incorporated issued 100 shares of$10 par value stock for $22 per share.
Let’s record this transaction.
Nelson, Incorporated issued 100 shares of$10 par value stock for $22 per share.
Let’s record this transaction.
100 shares × $22 per share = $2,200
100 shares × $10 par value = $1,000
11-20
Stock Classification
Account Title Debit CreditCash 3,750 Common Stock, Class B, $20 Par 3,000 Paid-in Capital in Excess of Par, Cl. B 750
Assume that Nelson has another class ofcommon stock, $20 par value Class B.The company issues 150 shares of Class Bcommon stock at $25 per share.
Let’s record this transaction.
Assume that Nelson has another class ofcommon stock, $20 par value Class B.The company issues 150 shares of Class Bcommon stock at $25 per share.
Let’s record this transaction.
150 shares × $25 per share = $3,750
150 shares × $20 par value = $3,000
11-21
Assume that Nelson issues 100 shares of 7 percentcumulative preferred stock with a stated value of$10 per share at a price of $22 per share.
Let’s record this transaction.
Assume that Nelson issues 100 shares of 7 percentcumulative preferred stock with a stated value of$10 per share at a price of $22 per share.
Let’s record this transaction.
Account Title Debit CreditCash 2,200 Preferred Stock, $10 Stated Value 1,000 Paid-in-Capital in Excess of Par, Prf. 1,200
100 shares × $22 per share = $2,200
100 shares × $10 par value = $1,000
Stock Issued with Stated Value
11-22
Stock Issued with No Par Value
Assume that Nelson issues 100 shares of nopar common stock at a price of $22 per share.
Let’s record this transaction.
Assume that Nelson issues 100 shares of nopar common stock at a price of $22 per share.
Let’s record this transaction.
Account Title Debit CreditCash 2,200 Common Stock, No Par 2,200
100 shares × $22 per share = $2,200
11-23
Financial Statement Presentation
11-24
Show how treasury stock transactions
affect financial statements.
LO 3
11-25
No voting or
dividend rights
Contra equity
account
When stock is reacquired, the corporation records the treasury stock at cost.When stock is reacquired, the corporation records the treasury stock at cost.
Treasury shares are issued shares that have been reacquired by the corporation.
Treasury shares are issued shares that have been reacquired by the corporation.
Treasury Stock
11-26
Why woulda company
buy itsown stock?
Why woulda company
buy itsown stock?
Treasury Stock
Common reasons include:
Employee stock option plans.
Preparation for a merger.
To increase earnings per share.
Supporting the stock price.
To avoid a hostile takeover.
Common reasons include:
Employee stock option plans.
Preparation for a merger.
To increase earnings per share.
Supporting the stock price.
To avoid a hostile takeover.
11-27
Treasury Stock
Account Title Debit CreditTreasury Stock 1,000 Cash 1,000
50 shares × $20 per share = $1,000
Assume that Nelson paid $20 per share to buyback 50 shares of the $10 par value stock thatit originally issued at a price of $22 per share.
Let’s record this transaction.
Assume that Nelson paid $20 per share to buyback 50 shares of the $10 par value stock thatit originally issued at a price of $22 per share.
Let’s record this transaction.
11-28
Treasury Stock
Account Title Debit CreditCash 750 Treasury Stock 600 Paid-in Capital in Excess of Cost of Tr. Stk. 150
30 shares × $25 per share = $750
Assume Nelson resells 30 shares of its treasurystock at a price of $25 per share.
Let’s record this transaction.
Assume Nelson resells 30 shares of its treasurystock at a price of $25 per share.
Let’s record this transaction.
30 shares × $20 cost = $600
No gain or loss is recognized on sale of treasury stock.
11-29
Explain how dividends, stock
splits, and appropriations affect financial
statements.
LO 4
11-30
Corporations are not required to pay dividends, but once declared, dividends are legal obligations.
DividendsStockholders
Cash Dividends
Corporation
11-31
Three important dates
Cash Dividends
Date of Record
No entryrequired.
Payment DateRecord payment of
cash to stockholders.
Declaration Date
Record liabilityfor dividend.
Dividends
11-32
Declaration Date
On October 15, 2012, Nelson’s board of directors declared a cash dividend on the 100 outstanding shares of its 7%, $10 par preferred stock. The dividend will be paid on December 15 to stockholders of record on November 15. Let’s record the entries.
On October 15, 2012, Nelson’s board of directors declared a cash dividend on the 100 outstanding shares of its 7%, $10 par preferred stock. The dividend will be paid on December 15 to stockholders of record on November 15. Let’s record the entries.
Account Title Debit CreditDividends 70 Dividends Payable 70
0.07 × $10 par × 100 shares = $70
Declaration Date
Record liabilityfor dividend.
Dividends
11-33
Date of Record
No entry required on November 15.
On October 15, 2012, Nelson’s board of directors declared a cash dividend on the 100 outstanding shares of its 7%, $10 par preferred stock. The dividend will be paid on December 15 to stockholders of record on November 15. Let’s record the entry
On October 15, 2012, Nelson’s board of directors declared a cash dividend on the 100 outstanding shares of its 7%, $10 par preferred stock. The dividend will be paid on December 15 to stockholders of record on November 15. Let’s record the entry
Date of Record
No entryrequired.
11-34
Payment Date
On October 15, 2012, Nelson’s board of directors declared a cash dividend on the 100 outstanding shares of its 7%, $10 par preferred stock. The dividend will be paid on December 15 to stockholders of record on November 15. Let’s record the entry
On October 15, 2012, Nelson’s board of directors declared a cash dividend on the 100 outstanding shares of its 7%, $10 par preferred stock. The dividend will be paid on December 15 to stockholders of record on November 15. Let’s record the entry
Payment DateRecord payment of
cash to stockholders.
Account Title Debit CreditDividends Payable 70 Cash 70
11-35
Stock Dividends
Distribution of additional sharesof stock to stockholders.
No change in total stockholders’
equity.
No change inpar values.
All stockholders retain same percentage ownership.
11-36
Stock Dividends
The journal entry moves an amount from
Retained Earnings to other equity accounts.
The journal entry moves an amount from
Retained Earnings to other equity accounts.
Nelson’s board of directors decided to issue a 10% stock dividend on the 150 outstanding shares of its $20 par value, Class B common stock. Market value at the time of the stock dividend was $30 per share. Let’s record the entry.
Nelson’s board of directors decided to issue a 10% stock dividend on the 150 outstanding shares of its $20 par value, Class B common stock. Market value at the time of the stock dividend was $30 per share. Let’s record the entry.
Account Title Debit CreditRetained Earnings 450 Common Stock, Class B 300 Paid-in-capital in Excess of Par, Class B 150
0.10 × 150 shares × $30 per share = $450
0.10 × 150 shares × $20 par = $300
11-37
Stock Splits
Stock splits replace existing shares with a greater number of new shares.
Companies use stock splits to reduce market price per share of their outstanding stock.
The number of outstanding shares increase and par value is decreased proportionately.
Retained earnings is not affected.
Stock splits replace existing shares with a greater number of new shares.
Companies use stock splits to reduce market price per share of their outstanding stock.
The number of outstanding shares increase and par value is decreased proportionately.
Retained earnings is not affected.
11-38
Stock Splits
Before Split
After Split
Common Stock Shares 165
Par Value per Share 20$
Total Par Value 3,300$
Nelson’s board of directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par value, Class B common stock.
Nelson’s board of directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par value, Class B common stock.
11-39
Stock Splits
Increase
Decrease
No Change
No journal entry required – Change par value and number of shares authorized and outstanding.
Before Split
After Split
Common Stock Shares 165 330
Par Value per Share 20$ 10$
Total Par Value 3,300$ 3,300$
Nelson’s board of directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par value, Class B common stock.
Nelson’s board of directors declared a 2-for-1 stock split on the 165 outstanding shares of its $20 par value, Class B common stock.
11-40
A corporation’s directors can voluntarily limit dividends because of a special need for cash.
Assume that Nelson’s board of directors appropriated $1,000 of retained earnings for future expansion. Let’s record the entry.
A corporation’s directors can voluntarily limit dividends because of a special need for cash.
Assume that Nelson’s board of directors appropriated $1,000 of retained earnings for future expansion. Let’s record the entry.
Appropriation of Retained Earnings
Account Title Debit CreditRetained Earnings 1,000 Appropriated Retained Earnings 1,000
11-41
Financial Statement Presentation
11-42
Explain some uses of
accounting information in making stock investment decisions.
LO 5
11-43
The Financial Analyst
DividendsIncrease in market
price per share
Stockholders benefit in two wayswhen a company generates
earnings.
11-44
Price-Earnings Ratio (P/E)
• Increases in a company’s stock price occur when investors believe the company’s earnings will grow.
• The price-earnings ratio , frequently called the P/E ratio, is the most commonly reported measure of a company’s value.
• The P/E ratio is a company’s market price per share of stock divided by the company’s annual earnings per share (EPS).
• However, caution must be used when interpreting P/E ratios.
11-45
End of Chapter Eleven
11-46