PROJECT ON ACCOUNTING

SUBMITTED TO: SIR KASHIF LUQMAN

SUBMITTED BY:
HAMMAD BIN AZAM HASHMI (046) USAMA JAVED SHAMAAIM ZAMAN WALEED AHMAD AHSAN ALAM (003) (131) (149) ()

STOCKHOLDER EQUITY
CORPORATIONS:
A corporation is a formal business association with a publicly registered charter recognizing it as a separate legal entity having its own privileges, and liabilities distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Corporations exist as a product of corporate law, and their rules balance the interests of the management who operate the corporation, creditors, shareholders, and employees who contribute their labor.

CHARACTERSTICS:
A number of characteristics distinguish a corporation from a sole proprietor or partnership. Unlimited life As a corporation is owned by stockholders and managed by employees, the sale of stock, death of a stockholder, or inability of an employee to function does not impact the continuous life of the corporation. Its charter may limit the corporation's life although the corporation may continue if the charter is extended. Limited liability The liability of stockholders is limited to the amount each has invested in the corporation. Personal assets of stockholders are not available to creditors or lenders seeking payment of amounts owed by the corporation. Creditors are limited to corporate assets for satisfaction of their claims.

Separate legal entity The corporation is considered a separate legal entity, conducting business in its own name. Therefore, corporations may own property, enter into binding contracts, borrow money, sue and be sued, and pay taxes. Stockholders are agents for the corporation only if they are also employees or designated as agents. Relative ease of transferring ownership rights A person who buys stock in a corporation is called a stockholder and receives a stock certificate indicating the number of shares of the company she/he has purchased. Particularly in a public company, the stock can be easily transferred in part or total at the discretion of the stockholder. The stockholder wishing to transfer (sell) stock does not require the approval of the other stockholders to sell the stock. Similarly, a person or an entity wishing to purchase stock in a corporation does not require the approval of the corporation or its existing stockholders before purchasing the stock. Once a public corporation sells its initial offering of stock, it is not part of any subsequent transfers except as a record keeper of share ownership. Privately held companies may have some restrictions on the transfer of stock. Professional management Investors in a corporation need not actively manage the business, as most corporations hire professional managers to operate the business. The investors vote on the Board of Directors who are responsible for hiring management. Ease of capital acquisition A corporation can obtain capital by selling stock or bonds. This gives a corporation a larger pool of resources because it is not limited to the resources of a small number of individuals. The limited liability and ease of

transferring ownership rights makes it easier for a corporation to acquire capital by selling stock, and the size of the corporation allows it to issue bonds based on its name. Government regulations The sale of stock results in government regulation to protect stockholders, the owners of the corporation. State laws usually include the requirements for issuing stock and distributions to stockholders. The federal securities laws also govern the sale of stock. Publicly held companies with stock traded on exchanges are required to file their financial statements and additional informative disclosures with the Securities and Exchange Commission. Certain industries, such as banks, financial institutions, and gaming, are also subject to regulations from other governmental agencies.

PROBLEM OF CORPORATIONS:
Disadvantages Fees: It costs money to incorporate. There are four types of fees: a fee to file the Articles of Incorporation with the Secretary of State, a first-year franchise tax prepayment, fees for various governmental filings, and attorneys' fees. But every year, tens of thousands of businesses choose to incorporate online without the use of an attorney. For example, basic incorporation before filing fees at a site like LegalZoom.com costs just $99. Formalities: The proper corporate formalities of organizing and running a corporation must be followed, to receive the benefits of being a corporation. Paperwork: Paperwork is a huge component of the corporate formalities that must follow. Reports and tax returns must be compiled and filed in a timely fashion; business bank accounts and records must be maintained

and kept separate from personal accounts and assets; records must be kept of corporate actions, including meetings of shareholders and Board of Directors; and licenses must be maintained. Disclosure of names of corporate officers and directors: Most states do not require that names of shareholders be a matter of public record; however, many states require that the names and addresses of corporate officers and directors be listed on one or more documents filed with the Secretary of State. Dissolution: Since corporations have a perpetual existence, states provide a mechanism for dissolving a corporation and liquidating its assets. Dissolution does not happen automatically. A corporation can be dissolved voluntarily or involuntarily. A corporation's officers and directors are charged with responsibility for dissolving the corporation, including gathering corporate assets, paying creditors and outstanding claims, and distributing the remaining assets to shareholders. Tax consequences: C corporations have potential double-tax consequences once when the company makes its profit, and a second time when dividends are paid to shareholders. S corporations can mitigate this tax issue.

TYPES OF CORPORATIONS: Businesses may choose from a variety of corporate entities, based on their needs. Below are useful descriptions.

General Corporation A general corporation, also known as a C corporation, is the most common corporate structure. A general corporation may have an unlimited number of stockholders. Consequently, it is usually chosen by those companies planning to have more than 30 stockholders or large public stock offerings. Since a corporation is a separate legal entity, a stockholders personal liability is usually limited to the amount of investment in the corporation and no more. Close Corporation A close corporation is most appropriate for the individual starting a company alone or with a small number of people. There are a few significant differences between a general corporation and a close corporation. A close corporation limits stockholders to a maximum of 30. In addition, many close corporation statutes require that the directors of a close corporation must first offer the shares to existing stockholders before selling to new stockholders. Not all states recognize close corporations. Subchapter S Corporation A Subchapter S Corporation is a general corporation that has elected a special tax status with the IRS after the corporation has been formed. Subchapter S corporations are most appropriate for small business owners and entrepreneurs who prefer to be taxed as if they were still sole proprietors or partners. When a general corporation makes a profit, it pays a federal corporate income tax on the profit. If the company also declares a

dividend, the stockholders must report the dividend as personal income and pay more taxes. S Corporations avoid this double taxation (once at the corporate level and again at the personal level) because all income or loss is reported only once on the personal tax returns of the stockholders. For many small businesses, the S Corporation offers the best of both worlds, combining the tax advantages of a sole proprietorship or partnership with the limited liability and enduring life of a corporate structure. S Corporation Restrictions To elect S Corporation status, your corporation must meet specific guidelines. All stockholders must be citizens or permanent residents of the United States. The maximum number of stockholders for an S Corporation is 75. If an S Corporation is held by an electing small business trust, then all beneficiaries of the trust must be individuals, estates or charitable organizations. Interests in the trust cannot be purchased. S Corporations may only issue one class of stock. No more than 25 percent of the gross corporate income may be derived from passive income.

Corporate Structure: While there might be slight variations in the way a corporation is set up, the corporate structure does follow a basic pattern. How a corporation is owned public or private will also dictate the corporate structure. To someone unfamiliar with the inner workings of the corporate world, it can be seem very confusing. A Two-Tiered System Stockholders are the owners of publicly owned corporations. Allowing each stockholder a vote or say on every matter would be unwieldy, so corporations set up a Board of Directors. The members of the Board of Directors are elected and voted on by the stockholders. Members of the Board of Directors come from within the corporations management structure (oftentimes the CEO or other top executives will be members of the Board), and they come from high-powered business, political, and academic leaders who are not otherwise affiliated with the corporation. The Board of Directors is run by a chairman who is elected to the position by the other members of the Board. The chairman is, technically, the top person within the corporations management structure. The other tier in the system is the management system within the corporation. These are the people who run the company on a daily basis. The top three positions in a typical corporation are the Chief Executive Officer (CEO), the Chief Operating Officer (COO), and the Chief Financial Officer (CFO). The CEO is responsible for the overall business operation and directly reports to the chairman of the Board of Directors. The COO is the hands-on management position, looking after sales and production activity and personnel. The CFO is responsible for tracking the financial well-being in the company, as well as providing regular reports to the Board of Directors, to the stockholders, and to the Securities and Exchange Commission. These three positions also carry other titles. The CEO can also be the president of the company; this title is designated depending on his position within the Board of Directors. The COO and CFO are usually senior vice presidents.

Corporate Ladder Everyone in the company ultimately reports to the Chairman of the Board of Directors. Within the management structure, the COO and CFO report to the CEO directly. From that point, the corporate structure widens to the vice presidents who oversee particular production or location areas, to managers who oversee a smaller region, and finally to the employees who make up the bulk of the corporations workforce. RIGHTS OF STOCKHOLDERS A. Common Stock (basic rights):

Voting rights Dividends - right to receive share of corp. earnings as their return on investment (ROI) Preemptive Right - right to maintain a proportionate ownership interest when new shares are issued. Liquidation - Right to a proportionate share of assets upon liquidation

Preferred Stock (basic rights): Dividend Preference - right to receive a dividend before common stockholders Liquidation Preference No voting rights

PREFERRED SHARES FEATURES OF PREFERRED SHARES: The following features are usually associated with preferred stock:

Preference in dividends. Preference in assets in the event of liquidation. Convertible into common stock. Callable at the option of the corporation. Nonvoting.

TYPES OF PREFERRED SHARES: Cumulative event financial conditions prevent a company from paying the fixed dividend, the unpaid amount accrues and must be paid at a later date (and before any common stock dividends are paid). Some cumulative stock is classified as "prior" or "preference." Companies often have several issues of preferred stock. In the event a dividend is delayed, those with prior or preference status get paid first. Callable ght to redeem or "call" preferred shares of stock as long as they pay for the shares at or above the market price. Many investors are wary of callable preferred stocks and with good reason. If economic conditions lead to a significant lowering of interest rates, calling preferred stock saves the company money, but the shareholders lose out on the income provided by the shares. Convertible means the stock can be exchanged after a stated time for a predetermined number of common stock shares. The shareholder has this option but is

under no obligation to convert the shares. If the owner does exchange the preferred shares for common stock, it's a one-way street. The stock cannot be switched back to preferred shares.

STOCKHODER EQUITY ACCOUNTING Two Sources of Equity Capital 1. 2. Contributed Capital - investments by stockholders Earned Capital - earnings retained in the business (Retained Earnings) Retained Earnings a. Increased by Net Income (with a credit) b. Decreased by net losses & dividends (a debit) Beginning Retained Earnings + Net Income (- Net Loss) - Dividends Ending Retained Earnings $ XX XX (XX) $ XX

Sample Stockholders Equity section of Balance Sheet:

Preferred Stock (# shares issued x $ par) Common Stock (# shares issued x $ par) Additional Paid in Capital: Preferred Common Treasury Total Contributed Capital Retained Earnings Treasury Stock (shares x $ cost) Total Stockholders Equity

$ XX XX XX XX XX XX XX (XX) XX

CAPITAL STOCK

1.

Authorized Shares: total no. of shares that may be issued

2. Issued Shares: total no. of shares issued to stockholders since formation 3. 4. Outstanding Shares: no. of shares held by outside stockholders Treasury Stock ISSUANCE OF STOCK 1. Par Value: a. establishes the corporations "legal capital" (minimum that must be maintained in SHE) THIS IS NOT CASH. b. Protects creditors by limiting the amount of assets that can be distributed to shareholders before liquidation c. Par is usually below anticipated selling price Examples: 1. Sold for par: (market price = par) Example: Sold 1,000 shares at $10 par 2. Sold stock for above Par Sold 1,000 shares, $1 par for $15/share:

3. Stock issued for non-cash asset: Record at FMV of stock traded or FMV of asset received, whichever is a better indicator of market value. Exchanged land for 10,000 shares of common stock, $1 par value. The FMV of the land is $300,000; however, the stock is traded daily at a selling price of $35 per share. DIVIDENDS Distribution of earnings to shareholders Usually in the form of cash. . Once board declares a dividend, it becomes a liability

A. Cash Dividends 3 Important Dates 1. 2. 3. Date of declaration - record the liability Date of record - stockholders as of the date of record are entitled to receive the dividends. Date of payment record distribution of cash

Effect of Cash Dividends Payment of dividends reduces cash AND Retained Earnings are reduced at closing:

Example: A corporation has the following shares outstanding: Preferred Stock (6%) 10,000 shares, $10 par $100,000 at par Common stock 200,000 shares at $1 par The yearly preferred dividend is calculated as $100,000 x 6% = $6,000 Debit Credit ------- -------6,000 6,000 $200,000 at par

Retained Earnings Dividends Payable

Thus, the preferred stockholders would receive up to the first $6,000 in dividends and common stockholders would receive any dividends beyond $6,000. Stock Dividends
Issue additional shares of common stock equal to worth of dividend. Each stockholder's % share of ownership remains the same.

Purpose: A corporation might declare a stock dividend instead of a cash dividend in order to 1) Increase the number of shares of stock outstanding 2) Move some of its retained earnings to paid-in capital 3) Minimize distributing the corporations cash to its stockholders.

Effect of Stock Dividend: 1. 2. 3. No effect on Total Stockholder Equity Increases Contributed Capital (increases # shares issued) Decreases Retained Earnings

Example: ABC Inc. has 10,000 shares of stock outstanding with a par value of $1 per share. On December 1, ABC declares a 10% stock dividend to be distributed on December 21 to stockholders of record on December 10. The market price of the stock on December 1 (the declaration date) is $5 per share. The dividend distributed to the stockholders will be 1,000 shares of stock (10,000 shares x 10%), so the recorded value of the dividend is $5,000 (1,000 shares x $5 market price per share). The entries to record the dividend would be as follows: Debit Credit ------- -------Retained Earnings 5,000 Stock Dividends Distributable 1,000 Paid-in-Capital in Excess 4,000 Stock Dividends Distributable Common Stock 1,000 1,000

Note that "Stock Dividends Distributable" is not a liability. It is actually a component of stockholders equity. This is in contrast to dividends payable for cash and property dividends. Dividends payable is a liability.

STOCK SPLITS A. Purpose: 1. 2. 3. Decrease market price of stock Increase number of shares outstanding Decrease (split) the par value

Example: Corporation has 20,000 shares, $10 par, market price = $200. Announce 2-for-l split. Result: Each shareholder now owns 2 shares of $5 par for each one share owned prior to split. Market price now = $100. Effect of Stock Splits 1. 2. 3. No change in value of corporation No change in total Shareholder Equity No change in Retained Earnings

TREASURY STOCK
The corporation re-acquires shares of its own stock from stockholders. Treated as a separate component of Shareholder Equity (reduces Shareholder Equity on the Balance Sheet)

Reasons to acquire treasury stock: To reissue the shares to officers and employees under bonus and stock compensation plans. To increase trading of the company's stock in the securities market in the hopes of enhancing its market value by signaling that management believes the stock is underpriced. To have additional shares available for use in the acquisition of other companies. To reduce the number of shares outstanding and thereby increase earnings per share. Treasury stock may be purchased if management is trying to eliminate hostile shareholders by buying them out. The purchase of treasury stock is generally accounted for by the cost method. Under the cost method Treasury Stock is increased (debited) for the price paid to reacquire the shares. Treasury Stock decreases by the same amount when the shares are later sold. The original paid-in capital account, Common Stock, is not affected because the number of issued shares does not change. Treasury stock is deducted from total paid-in capital and retained earnings in the stockholders' equity section of the balance sheet

EXAMPLE Acquisition of Treasury Stock When a corporation purchases its own shares in the market with the intent to reissue the shares at a later date, the repurchased shares are known as "Treasury Stock". Treasury stock is recorded at cost with no consideration of par or stated values. The account is a contra-equity account meaning that it has a debit balance and is shown as a negative component of stockholders' equity on the balance sheet. Example: ABC Inc. purchases 300 shares of its own stock at $5 per share. Debit Credit ------- -------1,500 1,500

Treasury Stock Cash

Note: Assume that this transaction is ABC's only Treasury stock. This example is continued in the section E on Reissuance of Treasury Stock. E. Reissuance of Treasury Stock If the corporation later reissues the Treasury Stock at more than it costs, the excess is credited to "Paid-in-Capital - Treasury Stock". A corporation can not show a gain from the sale of its own stock. Example: ABC Inc. reissues 100 shares of its Treasury Stock at $7 per share.

Debit Credit ------- -------Cash 700 Treasury Stock (100 shares x $5 cost) 500 Paid-in-Capital - Treasury Stock 200 If the corporation later reissues the Treasury Stock at less than its costs, the deficit is removed from "Paid-in-Capital - Treasury Stock" up to the extent that any credit balance exists in that account. Any remaining deficit is debited against "Retained Earnings". Example: ABC Inc. reissues the remaining 200 shares of its Treasury Stock at $3 per share. Debit Credit ------- -------Cash 600 Paid-in-Capital - Treasury Stock 200 Retained Earnings 200 Treasury Stock (200 shares x $5 cost) 1,000

CONCEPT OF RETAINED EARNINGS: Beginning retained earning Add: Net income Less: Stock dividend Cash dividend Total retained earning $ xxxx xxxx (xxxx) (xxxx) xxxx