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.

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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.

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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.

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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

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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

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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.

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End of Chapter Eleven

11-46