Chapter (13)

Corporations: Organization and Share Capital Transactions

The Corporate Form of Organization:

• Corporation
* Entity created by law.
* Separate and distinct from its owners.
• Two common bases for classification of corporations are:
1) By purpose.
 To earn profit, or
 Nonprofit.
2) By ownership.
 Publicly-held corporations.
* May have thousands of shareholders
* Shares are regularly traded on a national securities
exchange.
 Privately-held corporations.
* Often referred to as closely held corporations,
usually have only a few shareholders.
* Does not offer its shares for sale to the general public.

Characteristics of a Corporation:
• Separate legal existence from its owners.
• Shareholders have limited liability.
• Ownership held in shares of capital stock (transferable
units).
• Ability to acquire capital through the issuance of shares.
• Continuous life.
• Corporate management
– is at the discretion of the board of directors who are
elected by the shareholders
• Subject to numerous government regulations.
• Must pay an income tax on its earnings
• Shareholders are required to pay taxes on the dividends
they receive: the result is double taxation.

Advantages and Disadvantages of a Corporation:

Advantages:
1. Separate legal existence.
2. Limited liability of shareholders.

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 3. Transferable ownership rights
4. Ability to acquire capital.
5. Continuous life.
6. Corporation management – professional managers.

Disadvantages:
1. Corporation management – separation of ownership and
management.
2. Government regulations.
3. Additional taxes.

Ownership Rights of Stockholders:

1) Vote in election of board of directors and inactions that require
shareholders approval.
2) Share in corporate earnings through the receipt of dividends.
3) Preemptive right which means maintain the same percentage
ownership when additional shares are issued.
4) Residual claim share in assets upon liquidation.

Share Issue Considerations:

In considering the issuance of shares, a number of basic questions
must be resolved:
 How many shares should be authorized for sale?
 How should the shares be issued?
 What value should be assigned to the stock?

These questions are answered below:

Authorized Shares:
• Charter indicates amount of shares that a corporation is
authorized to sell
• Number of authorized shares is often reported in equity section
• No formal accounting entry

Issuance of Stock:
• Companies issue ordinary shares directly to investors or
indirectly through an investment banking firm
• Factors in setting price for a new issue of shares:
1. Company’s anticipated future earnings
2. Expected dividend rate per share
3. Current financial position
4. Current state of economy
5. Current state of securities market

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Par Value & No-Par Value Shares:
• Years ago, par value determined legal capital per share that a
company must retain in business for protection of corporate
creditors
• Today many governments do not require a par value
• No-par value shares is fairly common today
• In many countries, the board of directors assigns a stated value to
no-par shares

Corporate Capital:
• Owner’s equity in a corporation is identified as shareholders’
equity, or corporate capital.
• Shareholders’ equity section of a corporation’s statement of
financial position consists of:
1. Paid-in (contributed) capital:
Total amount of cash and other assets paid in to
the corporation by shareholders in exchange
for shares.
a. Share Capital—Ordinary Account
b. Preference Shares Account
c. Share Premium—Ordinary Account
d. Share Premium— Preference Account
2. Retained earnings (earned capital):
Net income that is retained in a corporation for future
use.

Net income is recorded in Retained Earnings by a closing entry in

which Income Summary is debited and Retained Earnings is credited.
For example, if net income for Delta Robotics is $130,000 in its first year
of operations, the closing entry is:

Date Account Title and Explanation Dr. Cr.

Income Summary 130,000
Retained Earnings 130,000
(to close income summary and transfer
net income to retained earnings).

If Delta Robotics has a balance of $8,000,000 in ordinary shares at

the end of its first year, its equity section is as follows:

Delta Robotics

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 Statement of Financial Position (partial)

Equity:
Share Capital-Ordinary $8,000,000
Retained Earnings 130,000
Total Equity $9,300,000

Accounting for Share Transactions

Accounting for Ordinary Shares
Primary Objectives:
1. Identify the specific sources of capital.
2. Maintain the distinction between share capital and
retained earnings.
 The issuance of ordinary shares affects only Share
Capital—Ordinary accounts.

Issuing Par Value Ordinary Shares for Cash

Example:
Assume that Hydro-Slide SA issues 1,000 shares of $1 par
value ordinary shares. Prepare Hydro-Slide’s journal entry if (a)
1,000 shares are issued for €1 per share, and (b) 1,000 shares are
issued for $5 per share.
a.
Date Account Title and Explanation Dr. Cr.
Cash 1,000
Share Capital - Ordinary 1,000

b.

Date Account Title and Explanation Dr. Cr.

Cash (1,000 shares × $5 issuance price) 5,000
Share Capital-Ordinary (1,000 shares ×
$1 par value) 1,000
Share Premium-Ordinary
(1,000 shares × $4) 4,000

Hydro-Slide. Inc.

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 Statement of Financial Position (partial)

Equity:
Share Capital-Ordinary $2,000
Share Premium-Ordinary 4,000
Total paid-in capital 6,000
Retained Earnings 27,000
Total Equity $33,000

Issuing No-Par Ordinary Shares for Cash

Example:
Assume that instead of $1 par value shares, Hydro-Slide SA has $5
stated value no-par shares and the company issues 5,000 shares at $8 per
share for cash.

Date Account Title and Explanation Dr. Cr.

Cash (5,000 shares × $8 issuance price) 40,000
Share Capital- Ordinary (5,000 shares × $5
stated value) 25,000
Share Premium-Ordinary (5,000 shares × $3) 15,000
(To record issuance of 5,000 €5 stated value no-par
shares)

Example:
If Hydro-Slide Inc. does not assign a stated value to its no-par share, the
issuance of the 5,000 shares at $8 per share for cash is recorded as follows:

Date Account Title and Explanation Dr. Cr.

Cash (5,000 shares × $8 issuance price) 40,000
Share Capital- Ordinary (5,000 shares × $8) 40,000

(To record issuance of 5,000 no-par shares)

Issuing Ordinary Shares for Services or Non-cash Assets

* Corporations also may issue shares for:
• Services (attorneys or consultants)
• Non-cash assets (land, buildings, and equipment)

* Cost is either the fair market value of the consideration given up (the
shares), or the fair market value of the consideration received (the
services or the asset), whichever is more clearly determinable.

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Ordinary Shares for Services
Example:
Attorneys have helped Jordan Company incorporate. They have billed
the company $5,000 for their services. They agree to accept 4,000 shares of
$1 par value ordinary shares in payment of their bill. At the time of the
exchange, there is no established market price for the shares. Prepare the
journal entry for this transaction.

In this case, the market value of the consideration received (the attorney
services) $5,000 is more clearly evident. Accordingly, the entry is recorded
in the following manner:

Date Account Title and Explanation Dr. Cr.

Organization Expense 5,000
Share Capital-Ordinary (4,000 shares × 4,000
$1 par value)
Share Premium-Ordinary 1,000

(To record issuance of 4,000 $1 par value

shares to attorneys)

Ordinary Shares for Non-Cash Assets

Example:
Athletic Research AG is an existing publicly held corporation. Its $5
par value shares are actively traded at $8 per share. The company issues
10,000 shares to acquire land recently advertised for sale at $90,000.
Prepare the journal entry for this transaction.

The most clearly evident value is the MARKET VALUE of the

consideration given (the shares: 10,000 shares × $8 per share), which is
$80,000. This transaction is recorded in the following manner:

Date Account Title and Explanation Dr. Cr.

Land (10,000 shares × $8 share price) 80,000
Share Capital-Ordinary (10,000 shares 50,000
× $5 par value)
Share Capital-Premium (10,000 shares 30,000
×$3)

(To record issuance of 10,000 $5 par value

shares for land)

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 Accounting for Preference Shares
Typically, preferred shareholders have a priority as to:
1. Distributions of earnings (dividends).
2. Assets in event of liquidation.

Generally do not have voting rights.

Accounting for preference shares at issuance is similar to that for ordinary
shares.

Example:
Florence Spa issues 10,000 shares of $10 par value preference shares for
$12 cash per share. The journal entry to record the issuance is:

Date Account Title and Explanation Dr. Cr.

Cash 120,000
Share Capital-Preference (10,000 shares
× $10 par value) 100,000
Share Premium-Ordinary (10,000 shares
× $2) 20,000

(To record issuance of 10,000 shares $10 par

value at ¥12 per share)

Accounting for Treasury Stock:

Treasury shares are a corporation’s own shares that it has reacquired
from shareholders but not retired.

Corporations acquire treasury shares for various reasons:

1. To reissue the shares to officers and employees under bonus
and share compensation plans.
2. To enhance the share’ smarket value.
3. To have additional shares available for use in the
acquisition of other companies.
4. To increase earnings per share.

Purchase of Treasury Shares:

* Treasury stock is generally accounted for by the cost method. Under
the cost method, Treasury Stock is debited for the price paid for the shares.
The same amount is credited to Treasury Stock when the shares are disposed
of (when the treasury shares are sold or reissued)

* Treasury shares is a contra equity account. It reduces equity.

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Example:
Assume that on February 1, 2020, the equity section of Mead, Inc. has
100,000 ordinary shares of $50 par value (all issued at par value) and retained
earnings of $2,000,000. The equity section before purchase of treasury shares
is as follows:
Mead, Inc.
Statement of Financial Position (partial)
Equity
Share Capital-Ordinary, $5 par value, 100,000 shares
issued and outstanding $5,000,000
Retained Earnings 2,000,000
Total equity $7,000,000

On February 1, 2020, Mead acquires 4,000 shares of its stock at $80 per
share. The entry is:

Date Account Title and Explanation Dr. Cr.

2020
Feb. 1 Treasury Shares (4,000 shares × $80 cost) 320,000
Cash 320,000

(To record purchase of 4,000 treasury shares at

$80 per share.)

Note that Treasury Stock is debited for the cost of the shares purchased.

In the equity section of the statement of financial position, treasury

shares is deducted from total share capital and retained earnings.

Treasury Stock is a contra equity account.

The equity section of Mead, Inc. after purchase of treasury shares is as

follows:
Mead, Inc.
Statement of Financial Position (partial)

Equity
Share Capital-Ordinary, $50 par value, 100,000
shares issued and 96,000 shares outstanding $5000,000
Retained Earnings 2,000,000
$7,000,000
Less: Treasury stock (4,000 shares) 320,000
Total equity $6,680,000

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 * Thus, the acquisition of treasury stock REDUCES equity.

* The term outstanding stock means the number of shares of issued

stock that are being held by shareholders.

Sale of Treasury Stock:

* Treasury shares are usually sold or retired. The accounting for its
sale is different when treasury shares are sold above cost than when it is sold
below cost.
* Selling price of the shares is greater than cost
• The difference is credited to Share Premium-Treasury
* Selling price is less than cost
• The excess of cost over selling price is usually debited
to Share Premium-Treasury account. When there is
no remaining credit balance in Paid-in Share
Premium-Treasury account, the remainder is debited
to Retained Earnings.

Sale of Treasury Stock Above Cost:

Example (1):
On July 1, Mead, Ltd. sells for $100 per share 1,000 of the 4,000
treasury shares previously acquired at $80 per share. The entry is as follows.

Date Account Title and Explanation Dr. Cr.

July. 1 Cash (1,000 shares × $100 sale price) 100,000
Treasury Shares (1,000 shares × $80 cost) 80,000
Share Premium—Treasury
(1,000 shares × $20 above cost) 20,000

To record sale of 1,000 shares of treasury

shares above cost.

Note: The $20,000 credit in the entry would not be considered

a gain on sale of treasury shares because a corporation does not realize a gain
or suffer a loss from shares transactions with its own shareholders.

Sale of Treasury Stock Below Cost:

Example (2):
If Mead, Ltd. sells an additional 800 treasury shares on October 1 at
$70 per share, it makes the following entry.

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 Date Account Title and Explanation Dr. Cr.
Oct. 1 Cash (800 shares × $70 sale price) 56,000
Share Premium—Treasury (800 shares × $10 8,000
below cost)
Treasury Shares (800 shares × $80 cost) 64,000

(To record sale of 800 treasury shares below

cost.

Example (3):
On December 1, assume that Mead, Ltd. sells its remaining 2,200 shares
at $70 per share and makes the following entry.

The excess of cost over selling price = 2,200 × $10 = $22,000

Since the Share Premium—Treasury account has only a credit balance

of $12,000 after Oct. 1 transaction, it is debited for that amount and the
remaining $10,000 is debited to the Retained Earnings account as shown
below:

Date Account Title and Explanation Dr. Cr.

Dec. 1 Cash (2,200 shares × $70 sale price) 154,000
Share Premium—Treasury 12,000
Retained Earnings 10,000
Treasury Stock (2,200 shares × $80 cost) 176,000

(To record sale of 2,200 treasury shares below

cost).

 See the posting of transactions in examples 1, 2, and 3 to the share

premium-Treasury account and the Retained Earnings account below:

Share Premium-Treasury
Dr. Cr.
Oct. 1 8,000 July 1 20,000
Dec. 1 12,000

Retained Earnings
Dr. Cr.
Dec. 1 10,000 Balance Jan 1 2,000,000

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Statement Presentation of Equity
Companies report share capital and retained earnings in the equity
section of the statement of financial position. Sources of equity include:
1. Share capital. This category consists of preference and ordinary
shares. Preference shares are shown before ordinary shares
because of their preferential rights. Par value, shares authorized,
shares issued, and shares outstanding are reported for each class
of shares.

2. Share premium. This includes the excess of amounts paid over

par or stated value and share premium from treasury shares.

See illustration 13.11 Page 13-17 of your textbook (equity section).

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