Corporations and Stockholders' Equity

Advantages and Disadvantages of a Corporation

A corporation is a legal entity separate from its owners, offering unique benefits and challenges.

• Advantages: Limited liability, ease of transferring ownership, ability to raise capital, perpetual existence.

• Disadvantages: Double taxation, regulatory requirements, more complex management structure.

Stock and Stock Transactions

• Common Stock: Represents ownership in a corporation and a claim on part of the profits.

• Preferred Stock: Has priority over common stock in dividend payments and asset distribution.

• Treasury Stock: Shares repurchased by the corporation, reducing stockholders' equity.

• Authorized Stock: Maximum number of shares a corporation is legally permitted to issue.

• Outstanding Shares: Shares currently held by shareholders.

• Issuance of Stock: Can be for cash, property, or services. Example: Issuing stock for a building.

Stockholders' Equity Transactions

• Retained Earnings: Accumulated net income not distributed as dividends.

• Effect of Treasury Stock: Reduces total stockholders' equity.

• Journal Entries for Treasury Stock: Debit Treasury Stock, credit Cash.

• Dividends: Distribution of earnings to shareholders. Key dates: declaration, record, payment.

Accounting Principles and Standards

US GAAP and Standard-Setting Bodies

• US GAAP: Generally Accepted Accounting Principles, the standard framework for financial accounting in the US.

• FASB: Financial Accounting Standards Board, sets US GAAP.

• IASB: International Accounting Standards Board, sets international standards (IFRS).

• SEC: Securities and Exchange Commission, oversees financial reporting for public companies.

Key Accounting Principles

• Revenue Principle: Revenue is recognized when earned, not necessarily when received.

• Expense Principle: Expenses are recognized when incurred, matching them to related revenues.

• Double Taxation: Corporations pay taxes on income, and shareholders pay taxes on dividends.

Transaction Analysis

Types of Transactions

• Purchase of Assets: Can be for cash, on account, or with a bond.

• Issuance of Stock: Increases cash and equity.

• Declaration of Dividends: Reduces retained earnings and creates a liability.

Journal Entries

• Dividends: Declaration: Debit Retained Earnings, Credit Dividends Payable. Payment: Debit Dividends Payable, Credit Cash.

• Treasury Stock: Debit Treasury Stock, Credit Cash.

Financial Statements

Income Statement

Shows revenues and expenses, resulting in net income or loss.

Statement of Retained Earnings

Reconciles beginning and ending retained earnings, including net income and dividends.

Balance Sheet

Reports assets, liabilities, and stockholders' equity at a specific date.

Cash Flows

Statement of Cash Flows

Summarizes cash inflows and outflows in three sections:

• Operating Activities: Cash from core business operations.

• Investing Activities: Cash from buying/selling assets.

• Financing Activities: Cash from borrowing, repaying debt, issuing stock, and paying dividends.

Purpose and Analysis

• Purpose: To show how cash is generated and used.

• Positive Cash Flow: Indicates financial health; operating cash flow should be positive.

Key Terms and Definitions

• Accounts Payable: Amounts owed to suppliers.

• Accounts Receivable: Amounts owed by customers.

• Capital Stock: Total shares issued to shareholders.

• Corporate Charter: Legal document establishing a corporation.

• Board of Directors: Elected group overseeing corporate management.

• Limited Liability: Shareholders' losses limited to their investment.

Financial Ratios and Calculations

• Return on Equity (ROE):

• Return on Assets (ROA):

• Price Earnings Ratio (P/E):

• Earnings per Share (EPS):

Examples

• Issuing Stock for a Building: Debit Building, Credit Common Stock.

• Purchasing Treasury Stock: Debit Treasury Stock, Credit Cash.

• Paying Dividends: Debit Dividends Payable, Credit Cash.

Additional info:

• Some questions reference preparing full financial statements, which involves compiling the Income Statement, Statement of Retained Earnings, and Balance Sheet using the trial balance and adjusting entries.

• Articles of incorporation are filed with the state to legally create a corporation.

• Preferred dividends are typically calculated as a percentage of par value.