Hope Enterprise University College

Department of Accounting & Finance

Principles of Accounting II
Chapter Six: Accounting for Corporate Form Business Organization
6.1 Basics of Corporations
Definition
A corporation is an artificial person, created by law and having a distinct existence separate and
apart from the natural persons who are responsible for its creation and operation. A
corporation is considered to exist as a “person” separate from its owners. As a “person” a
corporation has the right to own property and the responsibility to use that property in a legal
way. The corporation can make contracts and otherwise act as a legal. The corporation may be
classified as a profit making and not for profit and these are further classified as private and
public.
Characteristics of a Corporation
As a legal entity, the corporation has certain characteristics that make it different from other
types of business organizations. The most important characteristics with accounting
implications are:
 Separate Legal Existence: a corporation acquires, owns and disposes of property in its
corporate name and may incur liabilities and enter into other types of contracts according
the provision of its charter or articles incorporation.
 Limited liability of stockholders-creditors may not look beyond the assets of the
corporation for satisfaction of their claims. Thus, the financial loss that a stockholder may
suffer is limited to the amount invested
 A transferable unit of ownership-the ownership in a corporation is divided into transferable
units known as shares of stock. A corporation may have several classes of shares of stock.
The transactions that occur daily on stock exchanges are independent transactions between
buyers and sellers. Thus, in contrast to the partnership, the existence of the corporation is
not affected by changes in ownership.
 Additional Taxes-as a separate entity, a corporation is subject to double taxes. A
corporation is usually required to pay the following types of taxes:
1. Income tax on its earnings;
2. When the earnings remaining after income tax are distributed to stockholders as
dividends, they are again taxed as income to the individuals receiving them
 Government Regulations-being created by law and owned by stockholders who have
limited liability, a corporation has less freedom of action than a sole proprietorship and
partnership. There are usually government regulations in such matters as: ownership of
real, retention of earnings and purchase of its own stock.
 Separation of Management from Shareholders: Most laws require that at least three
persons join together to form a corporation. The persons forming the corporation are called
 its incorporators. The incorporators fill out an application form for a charter (articles of
incorporation). The form is then reviewed by the appropriate government office.

After the charter has been granted, the incorporators and all subscribers or the owners of the
stock of the business (shareholders or stockholders) meet and elect a board of directors who
represent the stockholders and have final authority for all corporate actions. The board of
directors then meets to select the professional managers and to make any other decisions
needed to start the business. In general separation means, Stockholders Elect Board of
Directors – Board of Directors Appoint Officers – Officers Appoint Employees
6.2 Corporate Capital (Stockholders’ Equity)
The difference between total assets and total liabilities of any business is generally known as
capital or owner’s equity. The owner’s equity in a corporation is commonly called shareholders’
equity or stockholders’ equity or shareholders’ or stockholders’ investment. The two main
sources of stockholders’ equity are:
 Investments contributed by the stockholders, called paid-in capital
 Net income retained in the business, called retained earnings
The paid in capital includes common stock, preferred stock, PIC in excess of par common stock
and preferred stock, common stock subscribed and premium on treasury stock.
6.3 Characteristics of Capital Stock
The general term applied to the shares of ownership of a corporation is called Capital Stock.
Before we discuss characteristics of capital stock, we shall discuss terminologies related to
shares and the major rights that accompany ownership of a share of stock. Terminologies
related to shares:
1. Authorized stock-is the number of shares that a corporation is authorized to issue in its
charter by the government
2. Issued Stock-a number of authorized shares that has been issued to date
3. Treasury Stock-a number of issued stocks that are reacquired under various circumstances
4. Outstanding Stock-a number of issued stocks that are currently in the hands of the
shareholders (Issued Stock – Treasury Stock).
5. Par value or stated Value – is a monetary figure assigned to a stock. It the legal capital of a
corporation on a per share basis.
6. Stock Certificate – is the evidence of ownership issued to the shareholders
7. No Par Stock – a stock issued without par value. Most of the time, no par stock is assigned a
stated value by the board of directors, which makes it similar to par stock.
The Basic Rights of stock ownership
The basic rights that accompany ownership of a share of stock are:
1. The right to vote in matters concerning the corporation
2. The right to share in distributions of earnings of receive dividend
3. The preemptive right – 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 up on liquidation
Classes of capital stock
There are two classes of stock: common stock and preferred stock
Common Stock:
 Each share of common stock has equal right of voting or the right to vote
 They have secondary right in the distribution of earnings or dividend
 They have secondary claim to the asset of a corporation up on liquidation
 They could be par stock or non-par stock
Preferred Stock:
 Preferred stock is usually assigned a par value
 They have preferential rights in receiving dividends and as to claim to assets of a
corporation in case of liquidation.
 It does not provide the right to vote
Allocation of Dividend among Preferred and Common Stock
A corporation with both preferred stock and common stock may declare dividends on the
preferred stock first, which may be stated in monetary terms or as a percent of par, and then
on common stock.

Participating and Non-Participating Preferred Stock

Most preferred stock is nonparticipating. This means that a dividend to nonparticipating
preferred stock is ordinarily limited to a specified amount. Participating preferred stock is a
stock which provides for the possibility of dividends in excess of certain or a specified amount.
If preferred shares may participate with common shares to varying degrees, the contract must
be examined to determine the extent of participation.

Cumulative and Non-cumulative Preferred Stock

Most preferred stocks are not participating. However, most preferred stocks are cumulative.
That is, provision is usually made, to assure the continuation of the preferential dividend right if
at any time the directors pass (do not declare) the usual dividend. This means, in turn,
dividends should not be paid on the common stock unless regular preferred dividend and
preferred dividends in arrears, if any, are paid. Dividend in arrears means dividend in prior
years. Cumulative preferred stock is a stock on which the specified amount of dividend
accumulates. No common share receives dividend before the dividend in arrears on cumulative
preferred stock are paid. Non-cumulative preferred stock is a stock on which no accumulation
of dividends is provided for.

6.4 Issuing Capital Stock

A) Issuing Stock for Cash
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
received are debited and any liabilities assumed are credited.
The credit to stockholders’ equity differs, however, in that there are accounts for each class of
stock rather than for each stockholder. The capital stock may be issued:
 At a price equal to par value
 At a premium that is at price which greater than the par value
 At a discount that is at price which less than the par value

Stock Issuance at Par Value

Stock Issuance at Premium and Discount
Par stock is often issued by a corporation at price other than par. When stock is issued for the
price more than its par, the stock is said to be sold at a premium and the premium is credited to
either premium on common or preferred stock account or PIC in excess of par Common stock
or preferred stock account. When stock is issued for a price less than its par value, the stock is
said to be sold at a discount. The discount is either debited to Discount of Common stock or
preferred stock account or PIC in excess of par common and preferred stock account.
B) Issuing Stock for Asset Other Than Cash
When a capital stock is issued in exchange for assets other than cash, such as a land, buildings,
and equipment, the assets acquired should be recorded at their fair market value of the assets
or at the fair market price of the stock issued whichever is more objectively determinable.
C) Issuing No Par Stock
When no par stock is issued, the entire proceeds may be credited to the capital stock account,
even though the issuance price varies from time to time. When no par stock is issued, both
discount and premium shall not be recognized.
No par stock may be assigned a stated value per share and the excess of the proceeds over the
stated value is either debited or credited to paid- in capital in excess of stated value account.
Assigning a stated value makes it similar with par stock.
6.5 Stock Subscriptions and Stock Issuance
When the corporation sells stock directly to investors, the investors first enter into an
agreement with the corporation to subscribe to shares (apply to buy shares) at a specified
amount per share. This is called subscriptions. If the stock is subscribed for at par, the
subscription price is debited to the asset called Stock Subscription Receivable and credited to
the capital stock account Called Stock Subscribed. When the stock is subscribed for at a price
below or above par the stock subscription receivable is debited for the subscription price and
the stock subscribed account is credited for at par and difference is debited to a discount or
credited to a premium account. After a subscriber has completed the agreed payment, the
corporation issues the stock certificate and stock subscribed account is debited and the capital
stock account is credited.
6.6 Treasury Stock
A corporation may purchase some of its own outstanding stock or may accept shares of its own
stock in payment of a debt owned by a stockholder in the manner much the same as acquisition
by purchase. The accepted or purchased own stock is called Treasury Stock.
 Treasury stock is a stock that has been issued as fully paid and has been subsequently
reacquired by the corporation but has not been canceled or reissued. The various reasons why
a corporation may buy its own stock are:

 To provide share for resale to employees

 To provide shares for reissuance to employees as a bonus
 To support the market price of the stock
 To increase earnings per share by reducing the number of shares outstanding
Accounting for Treasury Stock
There are several methods of accounting for the purchase and the resale of treasury stock. A
commonly used method is known as the cost basis method. When a stock is purchased, the
account treasury stock is debited for its cost. When the stock is resold, treasury stock is
credited at its cost price for it and the difference between the cost price and the selling or
issuance price is debited or credited to an account entitled paid-in capital from sale of treasury
stock.
The stockholders’ equity indicates that 20,000 shares of stock were issued out of which 600 are
held as treasury stock. The number of shares outstanding is therefore, 19,400 and any dividend
declared would apply to 19,400 shares. If sale of treasury stock resulted in a net decrease in Paid
in Capital (PIC), the decrease may be reported as a reduction of paid in capital or it may be
debited to the retained earnings account.
Treasury Stock: The Par Value Method
The accounting for Treasury Stock transactions under the Par value Method is a little more
involved than under The Cost Method because the journal entry for the acquisition of Treasury
Stock uses Additional Paid-In Capital (APIC).
The accounting for reissuance of Treasury Stock under the Par value Method is same as under
The Cost Method. The only difference is that the Treasury Stock account is debited and credited
at par value. In general, under the par value method the following are the basic assumptions:
1. In all stock transactions, no gains or losses are shown on the income statement
2. The amount that goes into the Treasury Stock account is the Par value of the shares
3. Gains are credited APIC – TS account
4. Losses are debited APIC – TS account (if there is a balance in it) and then Retained
Earnings account. That is why Retained Earnings account cannot increase by share
transactions.
Example 1:
Assume that a corporation with an authorization of 10,000 shares of preferred stock of Br 100
par and 100,000 shares of common stock of Br 20 par, issued on half of each authorization at
par for cash. Record the investment

Example 2:
DMN Share Company issued 5,000 shares of Br 20 par preferred stock for cash at Br 30 per
share. Record the investment by the shareholders

Example 3: GG Share Company issued 10,000 shares of Br 10 par common stock for cash each
at Br 8. Record the transaction

Example 4: assume that a corporation acquired land for which the fair market price is not
determinable in exchange for 10,000 shares of its Br 20 par common stock with a current
market price of Br 25 per share. Record the transaction

Example 5: Beta Corporation, at the time of organization, issued 20,000 shares of no par
common stock at Br 50 per share and at a later date issued 5,000 additional shares at Br 40.
Record the investment.

Example 6: Alpha Corporation, On March 17, 2005, issued 5,000 shares of no par common
stock with a stated value of Br 10 at Br 14 per share for cash. On June 1, 2005, it issued 2,000
shares of the same common stock at Br 15. Instruction: record the issuance of no par common
stock with a stated value

Example 7: on January 1, 2004 BCD Corporation received subscription to 10000 shares of Br 10

par common stock form various subscribers at Br 15 with a down payment of 50% of the
subscription price. On June 1 and October 1, 2004 the corporation received the remaining 20%
and 30%, respectively and the stock certificate was issued on October 1. Instruction: record the
stock subscription and the related transaction
Example 8: the paid-in capital of a corporation is composed of common stock issued at a
premium and the detail is as follows:
Common stock Br 50 par (20,000 shares authorized and issued)..... Br 1,000,000
Premium on Common Stock.............................................................. 300,000
Retained Earnings ............................................................................. 51,000
Further assume that the following transactions were occurred involving treasury stock:
1. Purchased 1,000 shares of its own stock at Br 60 per share
2. Sold 200 Shares of treasury stock at Br 70
3. Sold 200 Shares of Treasury Stock at Br 55
Required:
1. Show all the necessary entries
2. Determine Total Stockholder’s Equity