Corporation and Stockholders' Equity Overview

Corporation

• A corporation is a separate legal entity from its owners.
• Ownership is represented by shares of stock.
• Corporations issue stock, which individuals or other companies purchase.
• Shareholders own a percentage of the company based on their stock holdings.
• Example: Bill Gates owns approximately 5% of Microsoft's outstanding stock, controlling 5% of the company.

Other Forms of Business

• Single Proprietorship:
  • Owned and operated by a single person.
  • The owner is responsible for all debt and transactions.
• Partnership:
  • Two or more individuals.
  • Each partner is responsible for the debt and transactions of other partners.

Advantages of Corporate Form

• Easy Transfer of Ownership: Shares can be traded daily and instantly without needing approval from other owners.
• Limited Liability: Stockholders are not personally responsible for the corporation's debts.
• Easy Generation of Capital: Investors are attracted to the corporate structure.
• Separation of Owners and Company: Individual poor decisions by one stockholder do not jeopardize others.

Disadvantages of Corporate Form

• Double Taxation:
  • Earnings are taxed at the corporate level.
  • Dividends are taxed again at the individual shareholder level.
  • Example:
    • Earnings before taxes: 1.00
    • Taxes (35% corporate rate): 0.35
    • Net Income: 0.65
    • Dividend paid to stockholder: 0.65
    • Taxes (15% individual rate): 0.10
    • Net income: 0.55
• Government Regulation: Corporations face closer scrutiny.
• More Difficult to Raise Debt Capital: Limited liability makes it less attractive for creditors to lend money.

Authority Structure in a Corporation

• Stockholders: Elect the Board of Directors.
• Board of Directors: Elects the Chairperson of the Board (CEO) and the President (COO).
• Chairperson of the Board (CEO) and the President (COO): Leads Vice Presidents, CFO, Controller (Accounting Officer), Treasurer (Finance Officer), and Secretary, who manage day-to-day operations.

Shareholder Rights

• Voting: The right to participate in managing the corporation by voting on important issues.
• Dividends: The right to receive a proportionate part of the corporation’s profits.
• Liquidation: The right to receive a proportionate part of assets after the corporation pays its liabilities in liquidation.
• Preemption: The right to maintain one’s proportionate ownership in the corporation.

Stockholders’ Equity

• Represents shareholders’ ownership interest in the corporation’s assets.
• Accounting Equation:
  • Assets = Liabilities + Stockholders’ Equity
  • Resources = Claims to Resources
  • Resources = Creditors’ Claims + Residual Claims
• Paid-In (Contributed) Capital:
  • Contributed by stockholders.
  • Includes Common Stock, Preferred Stock, and Paid-In Capital in Excess of Par.
• Retained Earnings:
  • Earned through profitable operations before being paid out as dividends.

How Shares of Stock are Traded

1. Petition the SEC: The company petitions the Securities and Exchange Commission (SEC).
2. SEC Approval: The SEC approves the stock issue.
3. Transfer Shares and Receive Money: An investment banker facilitates the transfer.
4. Initial Public Offering (IPO): Shares are offered to investors.
5. Investors Buy and Sell: Investors trade shares on the stock exchange (e.g., NYSE).
6. Pay Dividends: The company pays dividends to shareholders.

Classes of Stock

• Common Stock:
  • Stock that has voting rights.
  • Every corporation has it; basic form of capital stock.
  • Stockholders have all four rights unless specifically withheld.
• Preferred Stock:
  • Stock that has preferential treatment related to dividends and liquidation.
  • It is rare.
  • Hybrid between common stock and long-term debt.
  • Pays a fixed dividend, like interest on debt.
  • Stockholders have all four rights unless specifically withheld.

Par Value vs. No-Par Value Stock

• Par Value:
  • Legal capital.
  • Serves little purpose; it is an arbitrary amount assigned to stock historically used to protect creditors.
  • Par value ≠ market value (or stock price).
• No-Par Value Stock:
  • In some cases, no-par value stocks have stated values.

Number of Shares

• Authorized: Total number of shares allowed to be issued by the SEC.
• Issued: Total number of shares sold.
• Outstanding: Total number of shares held by stockholders, and not the company itself.

Stock Issuance

• Example 1: Issued 9,000 shares of 2 par value common stock for 22/share.
  • Cash (+A) (9,000 imes $22) = $198,000
  • Common Stock (+SE) (9,000 imes $2) = $18,000
  • Paid-In Capital in Excess of Par (+SE) = 180,000
• Example 2: Issued 600 shares of 5 par value common stock for 45/share.
  • Cash (600 imes $45) = $27,000
  • Common Stock (600 imes $5) = $3,000
  • Paid-In Capital in Excess of Par = 24,000
• Example 3: Issued 500 shares of no-par value common stock for 100,000.
  • Cash = 100,000
  • Common Stock – No Par = 100,000
• Example 4: Issued 6,000 shares of 10 par value preferred stock for 35/share.
  • Cash (6,000 imes $35) = $210,000
  • Preferred Stock (+SE) (6,000 imes $10) = $60,000
  • Paid-In Capital in Excess of Par = 150,000
• Example 5: Issued 1,000 shares of common stock (1 par) for 12, and 500 shares of preferred stock (10 par) for 40.
  • Cash (1,000 imes $12) + (500 imes $40) = $32,000
  • Common Stock (1,000 imes $1) = $1,000
  • Preferred Stock (500 imes $10) = $5,000
  • Paid-In Capital in Excess of Par = 26,000

Stock Issued for Non-Cash Assets

• Example 1: Issued 80,000 shares of 1 par value common stock for equipment valued at 100,000.
  • Equipment (+A) = 100,000
  • Common Stock (+SE) = 80,000
  • Paid-In Capital in Excess of Par (+SE) = 20,000
• Example 2: Stock Issued for Services: An attorney billed the company 25,000, and accepted 2,500 shares of 1 par value stock, valued at 10/share in the stock market.
  • Legal Expenses (+E; −SE) = 25,000
  • Common Stock (+SE) = 2,500
  • Paid-In Capital in Excess of Par (+SE) = 22,500

Convertible Preferred Stock

• Can be converted to common stock at the preferred stockholders’ discretion.
• Example 1: Issuance of convertible preferred stock of 50,000 for cash.
  • Cash (+A) = 50,000
  • Convertible Preferred Stock (+SE) = 50,000
• Example 2: Converting to 5,000 shares of 1 par value common stock.
  • Convertible Preferred Stock (−SE) = 50,000
  • Common Stock (+SE) = 5,000
  • Paid-In Capital in Excess of Par (+SE) = 45,000

Treasury Stock – Part of Equity

• Companies can return cash to owners by purchasing their shares.
• Stock purchased by its own company is called treasury stock.
• Treasury stock is recorded as a contra-equity account.
• It is recorded in the equity section with a negative balance.
• Treasury stock is not recorded as an asset.
• Gains and losses on the sale of treasury stock are not reported in the income statement.

Why Companies Buy Their Own Shares

1. Have stock available for employee stock options.
2. Belief that its stock is undervalued.
3. Desire to distribute cash to shareholders.
4. A