CHAPTER 13
Corporations: Paid-in Capital and the Balance Sheet
Chapter Outline
Objective 3: Prepare the stockholders’ equity section of a corporation’s balance sheet
A. The stockholders’ equity’ section of the balance sheet follows this format (Exhibit 13-8):
Paid-in capital:
Preferred stock
Paid-in capital in excess of par—preferred
Common stock
Paid-in capital in excess of par—common
Total paid-in capital
Retained Earnings
Total stockholders’ equity
B. Many companies combine several accounts.
C. Decision guidelines provide answers to important questions about stockholders’ equity.
Objective 4: Account for cash dividends
A. Corporations declare dividends from retained earnings and pay the dividends with cash.
B. The relevant dates for dividends:
1. Declaration date—the date the board of directors announces its intention to pay the dividend and the dividend becomes a liability. Dividends Payable is a current liability.
Retained Earnings (or Dividends) XX
Dividends Payable XX
2. Date of record—the date, also announced by the board of directors, that determines who receives the dividend. No journal entry needed.
3. Payment date—the date the dividend is paid.
Dividends Payable XX
Cash XX
C. Preferred stockholders have a dividend preference; that is, the preferred stockholders receive their dividend before the common stockholders. This dividend is stated either as a percentage of the preferred stock’s par value (10% preferred, $100 par) or as a specific dollar amount ($10 preferred, $100 par).
D. Cumulative preferred stock accumulates dividends each year until the dividends are paid.
1. Dividends passed or not paid are called dividends in arrears. Dividends in arrears are not a liability. All dividends in arrears plus the current year’s dividend must be paid before the corporation can pay dividends to the common stockholders.
2. The corporation is not obligated to pay dividends on noncumulative preferred stock. Exhibit 13-9 shows the division of a dividend between preferred and common.
Objective 5: Use different stock values in decision making
A. The market value (market price) of a stock is its current selling price.
B. Liquidation value is the amount the corporation agrees to pay the preferred stockholder if the company liquidates.
C. Book value is a measure of the amount of net assets or stockholders’ equity per share.
1. Preferred =
book value
2. Common = Total stockholders’ equity – Equity allocated to preferred
book value Number of common shares outstanding
3. Book value may be used when negotiating the purchase of a business or when buying out a retiring executive. Traditionally, book value has been used to help evaluate the market price of stock. Exhibit 13-10 contrasts the book values and market values of several companies.
Objective 6: Evaluate a company’s return on assets and return on stockholders’ equity
A. Investors and creditors evaluate management’s ability to earn profits. Two key ratios are provided below:
1. Rate of return on Net income + Interest expense
total assets or = Average total assets
Return on assets
a. This ratio measures how well a company uses its assets to earn income.
b. Average assets are computed by adding beginning and ending assets and dividing by 2.
c. While rates of return vary from widely by industry, a return on assets of 10% is generally considered to be good.
2. Rate of return on = Net income – Preferred dividends
common stockholders’ equity Average common stockholders’ equity
or Return on equity
a. This ratio shows the relationship between net income and average common stockholders’ equity.
b. Compute average common stockholders’ equity by adding beginning and ending common stockholders’ equity (stockholders’ equity minus preferred equity) and dividing by 2.
B. The higher the rates of return, the more successful the company. Return on equity should exceed the return on assets.
Objective 7: Account for the income tax of a corporation
A. Corporations pay income taxes in much the same way that individuals do.
B. A corporation records income tax expense on the income statement and income taxes payable on the balance sheet. These two amounts may be different.
1. Income tax expense is computed as follows:
Income before tax Income(income statement) tax rate
2. Income tax payable is computed as follows:
Taxable income Income(tax return) tax rate
C. The most important difference between income tax payable and income tax expense occurs when a corporation uses straight-line depreciation for financial reporting and the modified accelerated cost recovery system(MACRS) for the income tax return. If the income tax expense is greater than the amount owed to the IRS, the journal entry is:
Income Tax Expense XX
Income Tax Payable XX
Deferred Income Tax Liability XX
D. It is also possible for the income tax expense to be less than the amount owed to the IRS.
E. Decision guidelines provide an overview of dividends, stock values, evaluating operations, and accounting for income taxes.