ACCOUNTING FOR CORPORATE BUSINESS

Chapter 6: Accounting for a Corporate Business

A corporation is defined as “a body of persons granted a charter legally recognizing it as a separate entity
having its own rights, privileges, and liabilities distinct from those of its owners.” Authority to manage a
corporation is given by the owners and the board of directors to the corporate officers. Management of
contributed capital is too critical.

Unlike sole proprietors and partners, the stockholders will have no personal liability for the corporation’s debts.
A corporation is responsible for its actions and liabilities. Thus, the financial loss that a stockholder may suffer
is limited to the amount invested. The owners can sell their shares of stock without consulting or obtaining the
consents of other stockholders. It has also limitation like double taxation. Because the earning of a corporate
business is subjected to federal and state income taxes and when dividend is distributed to owners, again each
shareholder is individually taxed on dividend income collected from the corporation.

Formulation of a Corporation
To form a corporation, most states require individuals, called incorporators, to sign an application and file it
with proper state office. This application contains the article of incorporation. If this article is approved by the
state, it will be in effect and contract between the sate and incorporators. The company is then authorized to do
business. In other words, a corporation is organized under state law to carry on activities permitted by its charter
or the articles of incorporation that state the maximum number of shares of stock that the corporation will be
allowed to issue.

The number of shares held by shareholders is the outstanding shares; this is generally less than the number of
authorized shares in the article of incorporation. Stockholders transfer cash and other resources to the
corporation. In return, they receive share of stock representing a proportionate share of ownership in the
corporation.

Corporation ownership is evidenced by shares of stock. The stockholders may transfer their shares at will. The
corporation may have more than one kind of stock. Stockholders elect a board of directors who:
 Appoints officers and employees.
 Decides on the major business policies of the corporation.
 Directs the operations of the business.
 Declares dividends to shareholders.

Characteristics of a Corporation
As a legal entity, the corporation has certain characteristics that make it different from other type of business
organizations.
 Limited liability  Transferability of ownership rights
 Owners are not agents  Government regulation
 Unlimited life  Double taxation

Advantages of the Corporate Form of Business

Separate legal entity Lack of mutual agency
Limited liability Continuous existence
Ease of capital generation Centralized authority and responsibility
Ease of transfer of ownership right Professional management
Disadvantages of the Corporate Form of Business
Government regulation
Double taxation
Separation of ownership and management
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Components of Stockholders’ Equity

In a corporation’s balance sheet, owners’ claims are called stockholders’ equity. The equity section is divided
into two parts.
1. Paid in Capital: It is Investments made by stockholders (both common stockholder and preferred
stockholders) and provides information about the corporation’s stock, such as types, par value, and number
of shares authorized, issued, and outstanding.
2. Retained Earnings: Represent stockholders’ claims to the assets of the company resulting from retained
profit from the operation of the corporation over its life.

The following is balance sheet presentation of stockholders’ equity. Stockholders’ equity section of the balance
sheet is:
Paid in capital:
Common stock……..…..…………......xx
Preferred stock…….…..………..….....xx
Retained earnings ………...…….………..…..xx
Total stockholders’ equity…….………xx

Classes of Stocks
The major rights of the shareholders are:
i. The right to attend stockholders’ meetings.
ii. The right to vote in the election of directors and on certain other matters.
iii. The right to receive dividends as declared by the board of directors.
iv. The right to inspect the corporation's books and records for reliability and accuracy at certain times and
places.

If there is only one class of stock, each share carries the same rights and privileges. When several classes of
stock exist, one class is usually designate common stock. Common stock represents the company’s residual
equity. All other creditors and preferred shareholders rank before common shareholders regarding claims to the
corporation’s assets. Common stock is usually the only stock with voting rights .This stock normally has all the
general rights and privileges, although other classes of stock may enjoy certain preferences over it.

One or more classes of stock may have certain preferred claims on the corporation's profits or on its assets at the
time of liquidation, or they may convey other special preferences that set them apart from the common stock.
This kind of stock is known as preferred stock. In receiving special preferences, the owner’s of preferred stock
may lose some of their general rights, such as the voting right.

Preferred Stock has preference over common stock in one or more areas.
– Preference as to dividends.
– Preference as to assets
Holders of preferred shares receive dividends before common shareholders. Common stocks shareholders are
not guaranteed dividends. Preferred shareholders have a right to receive the par value of their stock or a larger
stated liquidation value per share before the common stockholders receive any share of the company’s assets.

Accounting for Stock Issuance

Investment by stockholder is recorded in same way investment made by sole proprietor or partner is recorded.
Investment can be made by investing cash or non-cash assets and to record the entry, the cash or other asset is
debited, but the credit goes to stockholder equity, which is common stock or preferred stock depending on the
type of stock.
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 ACCOUNTING FOR CORPORATE BUSINESS

Example: Assume that XY Corporation has authorized 500,000 shares, Br100 par of common stock and
300,000 shares, Br 50 par of preferred stock. The corporation issued 100,000 shares of common stock and
50,000 shares of preferred stock at par for cash. The entry to record the issuance would be:

Cash……………………12,500,000
Preferred stock ………………..2, 500,000
Common stock……………… 10, 000,000

Issuance of stock at premium

The par value is the amount per share that is entered into the corporation’s capital stock accounts and that
makes up the legal capital of the corporation. Any amount in excess of par value received from the issuance of
stock (premium) is recorded in the Paid-in Capital in Excess of Par Value account.

No-par stock is capital stock issued with or without a stated value. Stated value may be assigned by the board of
directors. Without a stated value, all proceeds are recorded in the Capital Stock account. Without a par value,
shares are recorded in the Capital Stock account at the stated value.

Example: Assume the following for Dell Corporation.

Jan 1. Issued 10,000 shares of Br 10 par value common stock for Br 10 per share
Jan 5. Issued 10,000 shares of Br 10 par value common stock for Br 12 per share
The entries for the above transactions will be:
Par Value Stock
Jan 1. Cash ………………..100,000
Common Stock……………………………………….100,000
Jan 5. Cash ……………… 120,000
Common Stock………………………………………. 100,000
Paid-in Capital in Excess of Par Common Stock ……. 20,000

Treasury Stock
Treasury stock is capital stock, either common or preferred, that has been issued and later reacquired by the
issuing company and has subsequently been resold or retired. The company normally gets the stock back by
purchasing the shares on the market. A purchase of treasury stock reduces assets and stockholders’ equity.
A purchase of treasury stock is not a purchase of assets.

Purchase of treasury stock is recorded at cost. On the other hand, sale of treasury stock can be at cost, above
cost, or below cost. If it is sold above the cost, excess is credited to Paid-In Capital-Treasury Stock. On the
other hand, if it is sold below cost, the difference is debited to Paid-In Capital-Treasury Stock. Treasury stock is
retired when Company determines that it will not reissue the stock it has purchased.

Example: Assume the following transaction for ABC Corporation:

a. Purchased 1,000 shares of treasury stock at Br 45.
b. Sold 200 shares of treasury stock at Br 60.
c. Sold 200 shares of treasury stock at Br 40.
Entries:
a. Treasury stock ……………………………..45,000
Cash……………………………………………….45,000
b. Cash………………………………………..12,000
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Treasury stock………………………………….……9,000
Paid in capital from sale of treasury stock…………..3,000
c. Cash…………………………………………8,000
Paid in capital from sale of treasury stock….1,000
Treasury stock………………………………………..9,000
the total equity between the two classes.

HU, ACCOUNTING DEPARTMENT 4