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CHAPTER FIVE
Accounting for Corporations
Definition and Characteristics of a Corporation
Definition
A corporation is a separate legal entity chartered under law. Basically, upon the creation of a
corporation, a 'new person' is created in the eyes of the law. This 'person' has similar rights and
obligations that a real person would have and is expected to abide by the same laws and regulations
that govern all business activity. In corporations ownership is evidenced by a transferable share of
stock. Owners of a corporation are called stockholders or shareholders or stock owners.

Corporations may be classified based on their purpose and by ownership. Based on purpose
corporations can be classified as not-for-profit and for-profit. Not-for-profit corporations those
organized for recreational, educational, charitable, or other philanthropic purposes. For-profit
corporations are engaged in business activities. Based on their ownership for-profit corporations can
be classified further into public and non-public corporations. Public corporations are those whose
shares of stocks are widely distributed and traded in public market and may have thousands of
stockholders whereas non-public corporations are those whose shares are owned by a small group of
individuals.

Creating a corporation is more costly than organizing a proprietorship or partnership.

The expenditures incurred to organize a corporation are charged to Organization Costs,
an intangible asset account. These costs include attorney’s fees, fees paid to the
government, and costs of promoting the enterprise. Organization costs typically are
amortized.
Characteristics that distinguish corporations from proprietorships and partnerships
 Separate legal existence
 An entity separate and distinct from owners.
 Acts under its own name rather than name of stockholders.
 May buy, own, and sell property; borrow money; and enter into legally binding
contracts; may sue or be sued; and pays its own taxes.
 Owners (stockholders) cannot bind corporation unless owners are agents of the
corporation.
 Limited liability of stockholders
 Creditors have recourse only to corporate assets to satisfy claims.
 Liability of stockholders is limited to the extent of their investment in corporation.
 Creditors have no legal claim on personal assets of owners unless fraud has
occurred.
 Transferable ownership rights
 Ownership evidenced by shares of stock, which are transferable units.
 Transfer of ownership rights among stockholders has no effect on operating
activities of the corporation or on a corporation’s assets, liabilities and total
stockholders’ equity.
 Corporation does not participate in transfer of ownership rights after original sale of
capital stock.
 Ability to acquire capital

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 Limited liability of stockholders coupled with transferable ownership rights make it
easy for corporations to raise capital.
 Continuous life
 Life of corporation stated in charter - may be perpetual or limited to specific number
of years.
 If limited, period of existence can be extended through renewal of charter.
 Corporation is separate legal entity, thus life not affected by withdrawal, death, or
incapacity of stockholder.
 Corporation management
 Stockholders manage corporation indirectly through board of directors, which they
elect.
 Board of directors formulates operating policies and selects officers to execute
policy and to perform daily management functions.
 Government Regulations
Government prescribes requirements for issuing stock, distributions of earnings permitted to
stockholders, and the effects of retiring stock. It also requires disclosure of financial affairs to
the public through quarterly and annual reports.
 Additional Taxes
Stockholders must pay taxes on cash dividends. Thus, it may be argued that corporate income
is taxed twice—once at the corporate level and again at the individual level.
Stockholders’ Equity
A corporation is formed by filing articles of incorporation with the concerned governmental
body. The articles contain such information as:
 the name of the corporation;
 the purpose of the corporation; and
 the types and number of stock that the corporation is authorized to sell.
A corporation's balance sheet contains assets, liabilities, and a stockholders' equity section.

Stockholders' equity is made up of:

 Contributed capital (the stockholders' investment) and
 Retained earnings (earnings that have remained in the business).

The stockholders' investment (also called paid-up capital) is divided into shares (stocks),
and its owners are called shareholders or stockholders. Ownership in a corporation is
evidenced by a document called a stock certificate, which the shareholder receives when he
or she purchases shares in the corporation. The stock certificate shows the name of the
corporation, the stockholder’s name, the class and special features of the stock, the number of
shares owned, and the signatures of duly authorized corporate officials. Stock certificates are
pre-numbered to facilitate accountability.

In corporations, there is an easy transferability of ownership. A stockholder sells stock by

endorsing the stock certificate and sending it to the corporation's secretary or its transfer
agent. The secretary or transfer agent is responsible for transferring the corporation’s stock,
maintaining stockholders’ records, and preparing a list of stockholders for stockholders'
meetings and for the payment of dividends.

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Retained earnings is net income retained in the business for future use. It represents the
portion of the net income not distributed to shareholders. Unlike sole proprietorship and
partnership, incorporation the balance in the Income Summary account after revenues and
expenses are closed (it may be net income or net loss) is transferred to the Retained Earnings
account. The distribution of net income to the shareholders (which is called dividends) is
recorded in the Dividends account. At the end of the period the Dividends account is closed
to Retained Earnings account. Therefore, at any time the Retained Earning account may have
a debit or credit balance. If Retained Earnings account has a credit balance it represents the
portion of net income retained by the company and will be added to paid-up capital to
determine the stockholders’ equity. If Retained Earnings account has a debit balance it
represents a deficit and will be deducted from paid-up capital to determine the stockholders’
equity.
Characteristics of capital stock
As has been said earlier, the general term applied to the shares of ownership of a corporation
is capital stock. The amount of stock a corporation is authorized to sell is indicated the
corporate charter. If all authorized stock is sold, a corporation must obtain consent of the state
to amend its charter before issuing additional shares. The authorization of common stock does
not result in a formal accounting entry because the event has no immediate effect on either
corporate assets or stockholders’ equity. Disclosure of the number of shares authorized is
required in the stockholders’ equity section of the balance sheet.
When a corporation decides to issue stock it must answer the following questions:
 How many shares should be authorized for sale?
 How should the stock be issued?
 At what price should the shares be issued?
 What value should be assigned to the stock?

A corporation has the option of issuing common stock directly to investors or indirectly
through an investment banking firm that specializes in bringing securities to the attention of
prospective investors.

In setting the price for a new issue of stock, the following factors must be considered:
 the company’s anticipated future earnings,
 its expected dividend rate per share,
 its current financial position,
 the current state of the economy, and
 the current state of the securities market.

The shares of capital stock are often assigned an arbitrary monetary figure, known as par.
Par value stock is capital stock that has been assigned a value per share in the corporate
charter. The par value may be any amount selected by the corporation. Par value is usually
quite low because states often levy a tax on the corporation based on its par value. Par value
represents the legal capital per share that must be retained in the business for the protection
of corporate creditors. It is the amount that is not available for withdrawal by
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stockholders.

No-par value stock is capital stock that has not been assigned a value per share in the
corporate charter. No-par stock is stock for which par value has not been established; it may
be issued with or without a stated value. The board of directors is permitted to assign a
stated value to the no-par shares, which then becomes the legal capital per share. The stated
value of no-par stock may be changed at any time by action of the directors. Stated value,
like par value, does not indicate or correspond to the market value of the stock. When there is
no assigned stated value, the entire proceeds received upon issuance of the stock is
considered to be legal capital. The legal capital per share always establishes the credit to the
Common Stock account.
Classes of Stock
The major basic rights that accompany ownership of a share of stock are
1. The right to vote in matters concerning the corporations
2. The right to share in distribution of earnings
3. The preemptive right, which is the right to maintain the same fractional interest in
the corporation by purchasing a proportionate number of shares of any additional
issuances of stock, and
4. The right to share in assets upon liquidation

If a corporation issues only common stock, each share generally has equal rights. In addition
to common stock, a company can also issue preferred stock, which is used to attract investors
by giving them certain preferences over common stockholders. Holders of preferred stock are
given preference over common shareholders when dividends are declared.

Role of Share Holders

 Shareholders manage their organization indirectly.
 They elect members of the Board of Directors, which
 elects the officers of the corporation, and
 oversees the operations of the corporation.
 The board of directors has the sole authority to distribute earnings to the
stockholders.
 When such action is taken, the directors are said to declare dividend.
 A corporation cannot guarantee that its operations will be profitable and hence it
cannot guarantee dividends to its stockholders.
 Furthermore the directors have wide discretionary power in determining the extent
to which earnings should be retained by the corporation to provide for expansion, to
offset possible future losses, or to provide for further contingencies.
Issuing Capital stock
The entries to record investments of stockholders in a corporation are like those for investments
by owners of other types of business organizations, in that cash and other assets are debited and
the appropriate class of stock will be credited as stockholders’ equity.

As has been said earlier, par value is an arbitrary amount assigned to each share of stock which
constitutes the legal value of a share of stock. The common stock is not supposed to be sold

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initially by the corporation for less than the par value. Thus, creditors and other shareholders
know that the stock must be issued for a price above the par value. Also, the par value cannot
be returned to the shareholders at a later date. Dividends can only be paid out of earnings, not
par value. Legal capital equals the number of shares issued times the par value; it is the
minimum amount that can be reported as contributed capital.

Capital stocks can be issued (sold) for cash or other assets. Theoretically, there is no reason for
a newly organized corporation to issue stock at price other than par. If there is a need for an
additional capital long after the corporation is established, the price at which the stock can be
sold by a corporation is influenced by (1) the financial condition, the earning record, and the
dividend record of the corporation, (2) its potential earnings power, (3) the availability of
money for investment purpose, and (4) general business and economic conditions and prospects

When the stock is issued for a price above the par value the difference is called Premium and
if it is sold for a price below the par value the difference is called discount. When the issuance
of common stock for cash is recorded, the par value of the shares is credited to Common Stock
or Preferred Stock and the portion of the proceeds that is above or below par value is recorded
in a Paid-in Capital in Excess of Par account.
Example1- Issuing at Par
Ethio-Slide, Inc., issues 4,000 shares of Br 1 par value of common stock and 1,000 shares of Br
2 par value of preferred stock at par for cash. The entry to record the transaction is:
Cash..............................................6,000
Common Stock................................4,000
Preferred Stock................................2,000
Example 2- Issuing Above Par
Hafbo Inc., issues 20,000 shares of the Br 0.50 par value common stock for cash at Br 4 per
share. The entry is:
Cash.......................................................80,000
Common Stock..........................................................10,000
Paid-in Capital in Excess of Par Value-Common......70,000
If Hafbo Inc. has retained earnings of Br 30,000, the stockholders’ equity section of the balance
sheet would be: - (note that the asset and liability section of a corporation are the same as that
of sole proprietorship and partnership)
HAFBO INC.
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital
Common stock...........................................................10,000
Paid-in capital in excess of par value.......................70,000
Total paid-in capital.................................................. 80,000
Retained earnings......................................................30,000
Total stockholders’ equity.......................................110,000
Example 3- Issuing non-par, stated value stock
ABC Company issues 5,000 no-par common stocks with a stated value of Br 1.50 for
Br 5. The entries would be: -
Cash.........................................................25,000

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Common Stock.................................................................7,500
Paid-in Capital in Excess of stated Value-Common.......17,500
If the company issues no-par stock that does not have a stated value, the full amount received is
credited to the Common Stock Account and there is no need for the Paid-in Capital in Excess of
Par Value account.
Example 4- issuing non-par stock without stated value
Omega Ltd issues 30,000 non-par common stocks that don’t have a stated value for Br
4. The entries would be: -
Cash................................................120,000
Common Stock...........................................120,000
Capital Stock Issued for Non-cash Assets/Services
When stock is issued in exchange for assets or for services rendered, the stock should be
recorded at the fair market value of the assets or services, unless the fair market value of the
stock is more easily determined.
Example 5
Habtu Company purchased equipment with a fair market value of Br 150,000 by issuing
70,000 common stocks with a par value of Br 2. The entries would be: -
Equipment..................................................150,000
Common-Stock.............................................................140,000
Paid-in Capital in Excess of Par Value- Common........ 10,000
Types of Preferred Stocks
As has been said earlier a corporation may issue a class of stock in addition to common stock.
These stocks are called preferred stock. Preferred stock has contractual provisions that give it
preference or priority over common stock. Preferred stockholders do not have voting rights
but they have a priority in relation to:
1. Dividends and
2. Assets in the event of liquidation
Preferred stockholders have the right to share in the distribution of corporate income before
common stockholders. The per share dividend amount is stated as a percentage of the par value
of stock or as a specified amount. For example, BBB Co. may pay a 6% dividend on Br 20 par
value preferred (I.e., Br 20 X 6% = Br 1.20 per share), whereas NNN Co may pay Br 0.80 per
share dividend on its Br 10 par preferred stock.
If the dividend rate of preferred stock is Br 5 per share, common shareholders will not receive
any dividends in the current year until preferred stockholders have received Br 5 per share.
Once preferred stockholders have received the annual dividends to which they are entitled,
however, common stockholders generally receive the remainder.
Example 6
Dado Co has 2,000 shares of Br 3 preferred stock (i.e. annual dividend for preferred
stockholders is Br 3) and 8,000 shares of common stock outstanding. The net income, the
amount of annual dividend declared by the board of directors for 1996, 1997, 1998 and 1999
and the distribution of dividend is as follows
1996 1997 1998 1999
Net Income.................................................................. 40,000 35,600 57,000 105,000
Amount Retained........................................................ (10,000) (20,000) (15,000) (35,000)
Amount Distributed as Dividend.................................30,000 15,600 42,000 70,000
Dividend for Preferred Stockholders (2,000x3)……..6,000 6,000 6,000 6,000
Amount Left to Common Stockholders.......................24,000 9,600 36,000 64,800

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Dividend per Share
Common Stockholders............................................3.00 1.20 4.50 8.10
Preferred Stockholders..................................................3.00 3.00 3.00 3.00

As the above example indicates the preferred stockholders receive constant dividend. On the
other hand, holders of common stock have the possibility of receiving larger or smaller than
preferred stockholders.
The earnings of a corporation that are not retained in the business for growth and
expansion are distributed to the stockholders by means of dividends. Dividends are
paid only when formally declared by the board of directors of a corporation.

A cash dividend results in a decrease in assets (cash) and a commensurate

decrease in stockholders' equity (retained earnings).
In contrast, a stock dividend does not change assets, liabilities, or total
stockholder's equity. A stock dividend results in a transfer of retained earnings to
the permanent or contributed capital of the corporation by the amount of the stock
dividend. Therefore, a stock dividend affects only certain account balances within
stockholders' equity.
Procedures of Divided Payments: (There are three important dates in relation to
dividends)
 Declaration Date this is the date on which the board of directors
officially approves the dividend. As soon as it makes the declaration, it
creates a dividend liability, to be recorded in a journal entry.
 Date of Record This date follows the declaration date. It is the date on
which the corporation prepares the list of current stockholders based on
its stockholder records. The dividend is payable only to those names
listed on the record date. No journal entry is made on this date.
 Date of Payment this is the date on which the cash is disbursed to pay
the dividend liability. It follows the date of record as specified in the
dividend announcement.
The first claim to dividends does not, however, guarantee dividends. Dividends depend on
factors such as adequate retained earnings and availability of cash.
Preferred stocks are classified in different ways
1. Participating and Non-participating preferred stock
2. Cumulative and Non-cumulative preferred stock
Participating and Non-participating preferred stock
Holders of non-participating preferred stock will receive only constant amount of dividend as
indicated in the above example regardless of the amount of dividend declared. Holders of
participating preferred stock, on the other hand, will claim additional dividend if there is any
excess dividend after common stockholders receive a given amount of dividend.
Example 7
Cobra Co issued 1,000 shares of Br 2.00 preferred stock and 5,000 shares of common stock.
The contract governing the preferred stock provides that if the dividend per share for common
stock exceeds Br 5.00, the preferred stockholders will share the excess on share-for-share basis
(i.e. equally). The dividend for year 2003 is Br 34,500. The distribution of dividend is as
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follows: -

Preferred Common
Dividend Dividend TOTAL
Regular dividend for preferred (1,000 x2).........2,000 - 2,000
Dividend for Common (5,000 x 5)......... - 25,000 25,000
Remainder [(34,500-27,000) ÷6,000= 1.25]..... 1,250 6,250 7,500
TOTAL..........................................................3,250 31,250 34,500
Dividend per Share.................................. 3.25 6.25
Cumulative and Non-cumulative preferred stock
Preferred stock contracts often contain a cumulative dividend feature. If preferred stock is
cumulative, preferred stockholders must be paid both current-year dividends and any unpaid
prior-year dividends before common stockholders receive dividends. When preferred stock is
cumulative, preferred dividends not declared in a given period are called dividends in
arrears.
Example 8
To illustrate dividends in arrears, assume that Star Trading has 40,000 common stocks and
10,000 shares of 8%, $100 par value cumulative preferred stock outstanding. The annual
dividend is Br 80,000 [10,000 x (8% x Br 100 per share)]. The Company didn’t pay dividend
last year. Therefore, dividend is one year in arrears. Current year the Company declared a
dividend of Br 300,000. Since preferred stocks are cumulative preferred stockholders are
entitled to receive dividends of Br 160,000 as shown below before any distribution may be
made to common stockholders.
The Amount of Dividend......................................................................300,000
Dividend for preferred stockholders: -
Dividends in arrears (Br 80,000 x 1year).............................Br 80,000
Current-year dividends.......................................................... 80,000
Total preferred dividends....................... 160,000
Dividend for Common stockholders.................................................140,000
Note that
 Dividends in arrears are not a liability because no obligation exists until the board of
directors declares a dividend. The amount of dividends in arrears should be
disclosed in the notes to the financial statements. If the preferred stock doesn’t have
this cumulative right, the stock is called non-cumulative preferred stock. For the
non-cumulative preferred stockholders, the unpaid dividends are not carried over to
the next period.
 A dividend does not have to be paid at all because it is not debt. With non-
cumulative preferred stock, if no dividend is paid in one year, then the preferred
stockholders are never entitled to receive that dividend in future years. With
cumulative preferred stock, then all current dividends plus any missed dividends
from prior years (dividends in arrears) must be paid prior to any dividends being
paid to common shareholders.
Subscriptions and Stock Issuance
Sometimes a corporation may sell its stocks directly to investors under stock purchase plan. In
such cases the investor (the buyer) simply agrees to pay a certain price for a certain number of

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shares that will be bought in the future. The term may provide for payment in full at some
future date or for installment payments over a period of time. The stock certificate will be
issued by the corporation when the subscriber completed the agreed payment. Stocks can be
subscribed at or above par. When the subscriptions are made, we have the following journal
entry:
Example 9
Apr 3- Received subscriptions to 2,000 shares of Br 10 par common stock from various
subscribers at Br 13
Journalize the following transactions for MMM Company
Common Stock Subscriptions Receivable.....................26,000
Common Stock subscribed................................................20,000
Paid in Capital in Excess of Par- Common Stock............ 6,000
June 17- Received the total subscription amount and stock certificate is issued
Cash.......................................................................26,000
Common Stock Subscriptions Receivable......................26,000
Common Stock Subscribed...........................20,000
Common Stock.........................................................20,000
Treasury Stock
Treasury stock is a corporation’s own stock that has been issued, fully paid for, reacquired by
the corporation and held in its treasury for future use. A corporation may acquire treasury stock
to meet the following objectives:
 Reissue the shares to officers and employees under bonus and stock compensation
plans
 Increase trading of the company’s stock in the securities market in the hopes of
enhancing its market value
 Have additional shares available for use in the acquisition of other companies
 Reduce the number of shares outstanding and thereby increase earnings per share.
 Treasury stock may be purchased if management is trying to eliminate hostile
shareholders by buying them out.
There are several methods of accounting for the purchase and resale of treasury stock. A
commonly used method is the cost method. Under the cost method, when treasury stock is
purchased, Treasury Stock is debited for the purchase cost.
Example 10
At the beginning of the current year ABC Company has 20,000 shares of common stock with a
par value of Br 15 per share and issued at Br 20. On May 7, the Company repurchased 3,000 of
its outstanding common stock at Br 40 each. The journal entry is:
Treasury stock...................120,000
Cash...........................................................120,000
The stock may be reissued at cost, above cost, or below cost. When cash received from
reinsurance exceeds the cost, the difference is credited to Paid-in Capital from Sale of Treasury
Stock.
Example 11
Take the above example and assume that on June 14 ABC Company sold 1,000 shares for Br
40. Reissued shares of treasury stock at cost are recorded as follows: -

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Cash............................................................................40,000
Treasury Stock............................................................40,000
On August 19 ABC Company sold 400 shares for Br 50. Sale of shares of treasury stock at
above cost is recorded as: -
Cash.........................................................................20,000
Treasury Stock..............................................................16,000
Paid-in Capital from Sale of Treasury Stock..................4,000
On November 7 ABC Company sold 100 shares for Br 35. Sale of shares of treasury stock at
below cost is recorded as: -
Cash.........................................................................3,500
Paid-in Capital from Sale of Treasury Stock.............500
Treasury Stock..............................................................4,000
The original paid-in capital account, Common Stock, would not be affected because the number
of issued shares does not change. Treasury stock is deducted from total paid-in capital and
retained earnings in the stockholders’ equity section of the balance sheet on May 7 follow:

ABC Company
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital Common stock, Br 15 par value, 20,000 shares
issued and 17,000 outstanding................Br 300,000
Paid in Capital in Excess of Par.......................100,000
Total Paid in Capital.....................................400,000
Retained earnings...................................................... 200,000
Total paid-in capital and retained earnings.............600,000
Less: Treasury stock (3,000 shares)........................120,000
Total stockholders’ equity ............................Br480,000
Note
 Both the number of shares issued (20,000) and the number in the treasury 3,000)
are disclosed. The difference is the number of shares of stock outstanding
(17,000).
 Outstanding stock means the number of shares of issued stock that are being
held by stockholders.
 Treasury stock is not an asset; rather it reduces stockholder claims on corporate
assets.

Stock Dividends
Corporations issue stock dividends instead of cash dividends. A stock dividend is
a distribution of additional shares of a corporation's own capital stock on a pro
rata basis to its stockholders at no cost. Stock dividends usually consist of
common stock issued to the holders of common stock. Pro rata basis means that
each stockholder receives additional shares equal to the percentage of shares
already held. A stockholder with 10 percent of the outstanding shares receives 10
percent of any additional shares issued as a stock dividend.

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The value of a stock dividend is the subject of much debate. In reality, a stock div-
idend has no economic value, as such. All stockholders receive a pro rata
distribution of shares; which means that each owns exactly the same portion of the
company both before and after the stock dividend. The value of an investment is
determined by the percentage of the company that is owned, not the number of
shares that are held. If you get change for a dollar, you do not have more wealth
because you hold four quarters instead of only one dollar. Similarly, if you own
10 percent of a company, you do not have more wealth simply because the
company declares a stock dividend and gives you (and all other stockholders)
more shares of stock. At this point, you may still wonder why having extra shares
of stock does not make an investor wealthier.

The reason is simple: The stock market reacts immediately when a stock dividend
is issued, and the stock price falls proportionally.

If the stock price was Br 60 before a stock dividend, normally (in the absence of
events affecting the company) the price falls to Br 30 if the number of shares is
doubled. Thus, an investor could own 100 shares worth Br 6,000 before the stock
dividend (100 x Br 60) and 200 shares worth Br 6,000 after the stock dividend
(200 x Br. 30).

Illustration 9, Assume that M Company, issues a 100 percent stock dividend on

February 6, 20x6 to shareholders. M Company has 1,149,819,000 shares
outstanding. The par value of the shares was Br 0.10.
Date Accounts Debit Credit
20X6, Feb, 6 Retained Earnings (0.10 x 1,149,819,000) 114,981,900
Common Stock 114,981,900

Stock dividends are classified as either large or small. A large stock dividend
involves the distribution of additional shares that are more than 25 percent of the
currently outstanding shares. A small stock dividend involves additional shares
that are less than 25 percent of the outstanding shares. Because the M Company
stock dividend was equal to 100 percent of the outstanding shares, it should be
classified as a large dividend.

Notice that this journal entry moves an amount from Retained Earnings to the
permanent contributed capital of the company. The stock dividend did not change
total stockholders' equity-it changed only the balances of some of the accounts that
constitute stockholders' equity. This process of transferring an amount from
Retained Earnings to Contributed Capital often is called capitalizing earnings
because it reduces the amount of retained earnings available for future dividends.

The amount transferred from Retained Earnings to Contributed Capital was based
on the par value of the shares issued as a stock dividend. Par value is used when
the stock dividend is classified as large. In those cases, when a stock dividend is

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small (i.e., less than 25 percent), the amount transferred should be the total market
value of the shares issued.
Stock splits
Stock splits occur when management wishes to reduce the market price of stock so
that more investors can afford it. When stock is split, the par or stated value of the
stock is reduced as well as the market value. However, the amounts in the paid-in
capital accounts are not affected. Consequently, no journal entry other than a
memorandum entry is needed to record the split. A stock split affects only the par
value of the stock and the number of shares outstanding; the individual equity
account balances are not changed. Stock splits are not dividends. They are similar
to a stock dividend, but are quite different in terms of their impact on the
stockholders' equity accounts. In a stock split, the total number of authorized
shares is increased by a specified amount, such as a 2-for-1 split.

In this instance, each share held is called in, and two new shares are issued in its
place. Typically, a stock split is accomplished by reducing the par or stated value
per share of all authorized shares so that the total par value of all authorized shares
is unchanged.
If M Company executes a 2-for-1 stock split, it reduces the par value of its stock
from Br 0.10 to Br 0.05 and it doubles the number of shares outstanding. In
contrast to a stock dividend, a stock split does not result in a transfer of retained
earnings to contributed capital. No transfer is needed because the reduction in the
par value per share compensates for the increase in the number of shares. In both a
stock dividend and a stock split, the stockholder receives more shares of stock, but
does not disburse any additional assets to acquire the additional shares, A stock
dividend requires a journal entry; a stock split does not require one.
A stock split is disclosed in the notes to the financial statements.
The comparative effects of a stock dividend versus a stock split may be summa-
rized as follows:
Stockholders' Equity
After
Contributed Capital: Before 100% Stock Two-for-One
dividend Stock Split
Number of shares outstanding 30,000 60,000 60,000
Par value per share Br 10 Br 10 Br 5
Total par value outstanding 300,000 600,000 300,000
Retained earnings 650,000 350,000 650,000
Total stockholders' equity 950,000 950,000 950,000
Equity Per share
Equity per share (EPS) is the ratio of stockholder's equity to the related number of shares
of stock outstanding. If there is only one class of shares (common stock), equity per share
is computed as follows:
EPS= Total Stockholder's Equity
No. of Shares Outstanding
If there are both common and preferred shares, we have to allocate the total equity to
prefered and common stock. The equity to preferred stock is the liquidation value. The

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liquidation value is the amount that the preferred stockholders can claim if the
corporation is liquidated. The equity to preferred stock includes the dividends in arrears.
If the equity to the preferred stock is determined, the common equity is computed by
deducting equity to preferred stock from the total equity.
Then, EPS would be computed as follows:(If both are there)

Preferred EPS = Equity Allocated to Preferred Stock .

No. of Outstanding Shares of Preferred Stock
Common EPS = Equity Allocated to Common Stock .
No. of Outstanding Shares of Common Stock
The Retained Earnings account is a stockholders’ equity account with a normal credit
balance. As a result of net losses, however, a debit balance in Retained Earnings may
occur. Such a balance is called a deficit. The deficit reduces the total stockholders’ equity
of the corporation.
Illustration 10, Assume that the following balances appear on the balance sheet of ABC
Company:
Common stock, Br 10 par Br 600,000
Paid in Capital in excess of par 120,000
Deficit 75, 000
Total stockholders’ equity is Br 645,000 (Br 600,000 + Br 120,000 – Br 75,000) and the
number of share is 60,000 (Br 600,000/Br 10). The business has only common stock and
hence, the EPS is:
645,000/60,000 = 10.75
Illustration 11, Assume the following data:
Preferred, 10% stock, Br 50 par Br. 2,500,000
Premium on preferred stock 275,000
Common stock, Br. 25 par 3,750,000
Deficit 1,240,000
Assume also that Preferred stock has prior claim to assets on liquidation to the extent of
110% of par.
To compute EPS, let us first split the total equity into the two classes of shares:
Total Equity:
Preferred, 10% stock, Br 50 par Br. 2,500,000
Premium on preferred stock 275,000
Common stock, Br. 25 par 3,750,000
Deficit (1,240,000) Br 5,285,000
Less: Equity to preferred stock (110% x 2,500,000) 2,750,000
Equity to Common Stock Br 2,535,000
Therefore,
Preferred EPS = Br 2,750,000 = Br 55.00
2,500,000/Br 50
Common EPS = Br 2,535,000 = Br 16.90
3,750,000/Br 25

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