Comprehensive Guide to Stockholders’ Equity, Corporate Structure, and Dividend Policies

What is the default classification of a corporation under IRS Code?

C Corporation

What is the main tax difference between C Corporations and S Corporations?

C Corporations face double taxation, while S Corporations do not pay corporate income tax; income is taxed directly to stockholders.

What is the maximum number of shareholders allowed in an S Corporation?

100 shareholders

What are the two types of corporations based on purpose?

For-profit and Not-for-profit

What distinguishes publicly held corporations from privately held corporations?

Publicly held corporations have stock traded on a stock exchange, while privately held corporations do not offer stock to the general public.

What is one advantage of limited liability in corporations?

Investors can only lose their investment in the corporation, not personal assets.

How does a corporation act as a separate legal entity?

A corporation can enter contracts, borrow money, and engage in legal disputes independently of its stockholders.

What is the significance of ease of capital formation in corporations?

Corporations can raise capital by issuing shares of stock, allowing shareholders to determine their ownership interest.

What does unlimited life mean in the context of corporations?

Corporations continue to exist regardless of changes in ownership or management.

What is the process for forming a corporation?

A corporation must submit articles of incorporation to the state, which detail the business's general information.

What is treasury stock?

Stock that has been repurchased by the corporation and is held in its treasury.

What are the components of stockholders' equity?

Common stock, preferred stock, retained earnings, and accumulated other comprehensive income.

What is the disadvantage of double taxation in C Corporations?

Stockholders pay taxes on corporate earnings and again on dividends received.

What are the disadvantages of forming a corporation?

Formation requires substantial documentation, is expensive, and involves strict regulatory compliance.

What is the role of professional management in corporations?

Professional managers run the corporation, allowing stockholders to invest without managing daily operations.

What is the definition of owners' equity?

The owners' residual interest in the business, also known as net assets.

What is the purpose of articles of incorporation?

To provide legal documentation detailing the corporation's general information to the state.

What is the significance of a corporation's charter?

It recognizes the corporation as a legal entity subject to state law.

What is meant by 'transferability of ownership' in corporations?

Shareholders can easily sell their shares without needing consent from the company or other shareholders.

What are the restrictions on shareholders in an S Corporation?

Shareholders must be U.S. citizens or resident aliens, and there can only be one class of stock.

What is 'accumulated other comprehensive income'?

Income that is not included in net income and is reported separately in stockholders' equity.

What is contributed capital?

The total amount paid in on capital stock, also known as paid-in capital.

What rights do shares of capital stock typically carry?

1. Share in profits and losses proportionately. 2. Vote for directors. 3. Share in assets upon liquidation. 4. Preemptive right to new issues of stock.

What is common stock?

The residual corporate interest that bears the ultimate risks of loss and receives the benefits of success, not guaranteed dividends or assets upon dissolution.

What is preferred stock?

A special class of stock created by contract, where stockholders sacrifice certain rights for other rights or privileges, usually dividend preference.

What constitutes earned capital?

Capital resulting from profitable operations, including retained earnings and accumulated other comprehensive income.

What are retained earnings?

The net income to date that has not been distributed to owners, representing the earned capital of the company.

What is par value stock?

The dollar amount assigned to each share of stock in the company charter, which has no relationship to its fair value.

What is the purpose of low par values?

To help companies avoid a contingent liability when stock is sold below par value.

What accounts are used to record the issuance of common stock?

1. Common stock account for the par value of issued shares. 2. Paid-in-Capital in Excess of Par for any excess over par value paid in by stockholders.

What is no-par stock?

Stock for which no dollar amount per share is specified in the company charter, avoiding contingent liability and confusion over par value.

What are the two methods of allocating proceeds in lump-sum stock issuance?

1. Proportional method based on relative fair market values. 2. Incremental method when fair market value of all securities cannot be determined.

How should companies record stock issued for noncash transactions?

At the fair value of the stock issued or the fair value of the noncash consideration received, whichever is more clearly determinable.

What costs are associated with issuing stock?

Direct costs such as underwriting costs, accounting and legal fees, printing costs, and taxes, reported as a reduction of amounts recorded in Paid-in Capital in Excess of Par.

What preferences do preferred stockholders typically have?

Preferences include dividend preference, nonvoting rights, and liquidation preference.

How is accounting for preferred stock similar to common stock?

Preferred stock uses a preferred stock account for par value and an additional paid-in capital account for excess above par.

What is cumulative preferred stock?

Preferred stock that guarantees annual preference dividends, with passed dividends called dividends in arrears, which must be paid before current preferences.

What is participating preferred stock?

Preferred stock that allows holders to share ratably in additional dividends with common stockholders, either fully or partially participating.

What is convertible preferred stock?

Preferred stock that allows stockholders to exchange preferred shares for common shares at a predetermined rate.

What is callable preferred stock?

Preferred stock that can be redeemed by the corporation at a predetermined rate and specific future date.

What are the characteristics of redeemable preferred stock?

Allows stockholders to redeem preferred stock at any time for a specific amount per share, having both debt and equity characteristics.

How is treasury stock defined?

A company's own stock that has been reacquired, considered issued but not outstanding, and is a contra stockholders' equity.

What are the two methods for purchasing treasury stock?

Cost method (record purchase at acquisition cost) and Par (Stated) value method (record at par value and adjust for the difference).

What happens when treasury stock is sold?

Companies either re-issue or retire treasury stock, and the difference between sale price and original cost affects APIC-TS or Retained Earnings.

What is the accounting treatment for retiring treasury stock?

Involves canceling the treasury stock and reducing the number of shares issued, with debits to common stock, APIC-CS, and possibly Retained Earnings.

What are dividends?

Distributions to owners representing a return on investment to shareholders, requiring a positive balance in retained earnings to declare.

What are the types of dividends?

Cash dividends, property dividends (in kind), liquidating dividends (return of capital), and stock dividends (paid in shares of stock).

What are property dividends?

Dividends payable in assets other than cash, requiring restatement at fair value and recognizing any gain or loss.

What are liquidating dividends?

Dividends not based on retained earnings, representing a return of capital and reducing corporate paid-in capital.

What defines small stock dividends?

Dividends of less than 20 to 25 percent of common shares outstanding, transferring fair market value from retained earnings without changing total S/E.

What defines large stock dividends?

Dividends of more than 25 percent of common shares outstanding, transferring par value from retained earnings without changing total S/E.

What is the purpose of stock splits?

To reduce the market value of shares without recording an entry, decreasing par value and increasing the number of shares.

What is a reverse stock split?

An action to increase the market value of shares by increasing par value and decreasing the number of shares, without recording an entry.

How are restrictions on retained earnings disclosed?

Restrictions are best disclosed by note, based on retention of earnings balance, working capital requirements, and other considerations.

What is the maximum dividend that can be declared?

The maximum dividend is limited to the positive balance in retained earnings.

What is the accounting treatment for a stock dividend?

For small stock dividends, transfer fair market value from retained earnings; for large stock dividends, transfer par value.

What is the effect of dividends on stockholders' equity?

All dividends, except for stock dividends, reduce the total stockholders' equity in the corporation.

What is the significance of APIC in treasury stock transactions?

The difference between the sale price and original cost of treasury stock affects APIC-TS or may debit Retained Earnings.

What is the treatment of gains or losses on the sale of treasury stock?

No gain or loss can be recognized on the sale of treasury stock as it is considered an equity transaction.

What happens to total assets and stockholders' equity when treasury stock is sold?

The sale of treasury stock increases total assets and stockholders' equity.