CHAPTER SIX

CORPORATION, ORGANIZATION & OPERATION

Corporation-is a legal entity, distinct and separate from its owners. As an artificial legal
being, a corporation may acquire, own, and dispose of property in its own name. It may also
borrow money, enter into contract, sue and be sued.

Characteristics of a corporation
A number of characteristics distinguish a corporation from proprietorship
and partnership.
1. Separate Legal Entity:-A corporation acts as an artificial person separate and
distinct from its owners, who are called stockholders or shareholders.
2. Limited Liability:-The liability of stockholders is limited to their investment in the
corporation, and creditors have no legal claim on the personal assets of the owners.
3. Transferability of Ownership:-The ownership of a corporation is divided into
shares of stock, which are transferable units. This makes corporation to have a
continuous life regardless of changes in the ownership of their stock.
4. Unlimited Life:- the transfer of ownership interest does not affect the corporation’s
existence and operations.
5. Corporate Taxation:- Corporations are separate taxable entities. They pay a variety
of taxes not required for proprietorship and partnership.
6. Separation of Ownership and Management:- Stockholders own the business, but a
board of directors-elected by the stockholders-appoint corporate officers to manage
the business.
Advantages of the Corporate form of Organization
Several characteristics of corporation may make this form of organization more desirable
than either a partnership or a proprietorship.
1. Greater amount of capital can be raised-large number of individuals and
institutions can more easily and efficiently acquire and dispose of ownership interests
in a corporation than in a partnership.
2. Limited liability:- Owners’ liability is limited to the amount invested in the
corporation
3. Transferability of Ownership:- After the initial sale of stock, shares may be
transferred in private sale transactions; traded (sold) in without asking for approval
from the corporations management.
4. Unlimited life:- The transfer of shares does not affect the corporation’s ability to
operate routinely over decades.
5. Professional management-the excellent record of growth and earnings in most large
corporations indicate that the separation of ownership and control has benefited rather
than injured stockholders.
Disadvantages of the Corporate Form of Organization
1. Double taxation exists-the income of a corporation is taxed twice.
2. Government regulation exists-Corporations are subject to more government
regulations than either proprietorships or partnerships.
3. Not easy to form
4. Large setting up cost
 Formation of a Corporation
Creation of a corporation begins when its organizers, called the incorporators, obtain a
charter from the state. The charter includes the authorization for the corporation to issue a
certain number of shares of stock, which are shares of ownership in the corporation. To
obtain a corporate charter, an application called the articles of incorporation is submitted to
the state official.
The application (articles of incorporation) contains the following types of information:
 The name, purpose, and duration of the proposed corporation
 Amounts, kinds, and number of shares of capital stock to be authorized
 The address of the corporation’s principal office
 The name and address of the incorporators
After the charter is obtained, the stockholders in the new corporation hold a meeting to elect
board of directors and to establish by laws as a guide to the company’s affairs. The directors
in turn hold a meeting at which officers of the corporation are appointed.
The formation and organization of a corporation requires significant costs. Such cost is called
organization cost.
Organization Costs-are costs incurred in the formation of a corporation. Such costs include:
legal fees, taxes, state incorporation fees, and promotional costs. These costs are debited to an
intangible asset account entitled organization costs and are normally amortized over a five-
year period.
Example: On May 1, 2005 East Africa Co. paid the following expenditures at the time of its
formation.
Attorney’s fee 10,000
Incorporation fee 7,000
Stock Certificate printing cost 20,000
Other related expenditures 8,000
45,000
To record the payment of cash for organizing the corporation
May 1 Organization Costs 45,000
2005 Cash 45,000

Assuming the corporation amortizes the organization cost over 5 year, we will have a yearly
amortization expense of recorded as follows:

Amortization Exp-Orgn Cost 9,000

Organization Cost 9,000
(To record the amortization expense at the end of the year)
In the balance sheet, organization costs appear under the “Other Assets” section.

Rights of Stockholders
The ownership of stock in a corporation usually carries the following basic rights:
1. The right to receive a certificate as evidence of ownership interest, and to transfer
such shares as they choose (through either sale or gift).
2. The right to vote for Board of Directors and business matters
3. The right to share in profits by receiving dividends
4. To share in assets upon liquidation
5. The right to purchase a portion of any new shares issued in order to maintain the
same percentage of ownership (called preemptive right).
Characteristics of Stock Issuance
In considering the issuance of (or sale) of stock, a corporation must resolve a number of basic
questions:
 How many shares should be authorized for sale?
 How the stock be issued?
 At what price should it be issued?
 Should a par value or no-par value be assigned to the stock?
For purposes of discussion, these questions are considered under the following headings:
Capital Stock- a corporation issues stock certificates to its owners
in exchange for their investment in the business. The basic unit of
capital stock is called a share.
Stock Certificate- proof of stock ownership is evidenced by a printed or engraved form
known as a stock certificate. The face of the certificate shows the name of the corporation,
the stockholder’s name, the class and special features of the stock, the number of shares
owned, and the signatures of authorized corporate officials.
Authorized Capital Stocks- are the number of stocks that a corporation is authorized to sell;
which are indicated in its charter.
Issued Capital Stocks-are stocks, which are sold to investors either directly or indirectly
through a brokerage house (that specializes in bringing stocks to the attention of prospective
investors).
Outstanding Capital Stocks-are shares of capital stock issued by the
co. and still are being held by stockholders.
Par value of the stock-is an arbitrary monetary amount assigned to a single share of stock at
the time of authorization. Par value represents the legal capital per share that must be retained
in the business for the protection of corporate creditors.
No-par value stock- is capital stock that has not been assigned a value in the corporate
charter. Stocks are issued with no-par value to prevent confusion by investors between par
value and market value.
No-par with a stated value-a stated value serves the same purpose as par value. But since
stated value is not printed on the stock certificate, there is less risk of confusing investors.
In accounting for the issuance of stock, the par or stated value, if any, is recorded in the
common stock account.
Market value of stock-is the selling price or market price of stock.
Some of the factors that affect the market price of a stock are:
 Company’s earnings
 Dividend policy
 Interest rates
 Economic policy of presidents
Corporate Capital
The owner’s capital in a corporation is termed as stockholders’ equity, or corporate capital.
Sources of stockholders’ equity:
1. Paid-in capital (or contributed capital)-is the investment by the stockholders in
exchange for capital stock.
2. Retained earnings-is net income retained in the corporation through profitable
operation of the business.
CLASSES OF STOCK
In order to appeal to as many investors as possible, a corporation may issue more than one
kind of capital stock. The two types of stocks of a corporation are common and preferred.
Stockholders normally acquire one of two basic types of stock as evidence of their ownership
interest.
1. Common Stock-is the most basic /primary/ capital stock issue by the corporation to
stockholders.
 Common stockholders’ posses all the rights listed earlier.
 Common stockholders are the primary owners of a corporation.
 If only one class of stock is issued, it is common stock.
2. Preferred Stock-is a stock issued by corporations to appeal investors who are unwilling to
take all the risks involved in common stock ownership
 The rights of common stockholders are modified to provide the preferred
stockholders with certain advantages not available to common stock holders.
Most preferred stocks have the following distinctive features;
 Preferred as to dividends
The preferred stockholders are entitled to receive a dividend of specific amount before
any dividend is paid on the common stock.
The dividend is usually stated as a dollar amount per share or as a percentage of par
values.
 Cumulative dividend rights
The dividend preference carried by most preferred stock is a cumulative one. If all or
one part of the regular dividend on the preferred stock is omitted in a given year, the
amount omitted is said to be in arrears and must be paid in a subsequent year before
any dividend can be paid on the common stock.
 Preferred as to assets in event of the liquidation of the corporation
Most preferred stock carry a preference as to assets in the event of liquidation of the
corporation. If the business is terminated, the preferred stock is entitled to payment in
full of its par value or a higher stated liquidation value before any payment is made on
the common stock.
 Participating dividend right
The owners of participating preferred stock may receive-that participating in-
dividends beyond the stated amount or percentage.

 Callable at the option of the corporation.

Most preferred stocks include a call provision. This provision grants the issuing
corporation the right to purchase the stock from the stockholders at a stipulated call
price.
 Conversion privilege
In order to add to the attractiveness of preferred stock as an investment, corporation
sometimes offer a conversion privilege which entitles the preferred stockholders to
exchange their shares for common stock in a stipulated ratio.
 No voting right
Preferred stockholders give up some of the privileges accorded to common
stockholders. Eg; The right to vote for members of the Board of Directors. Preferred
stocks vary widely with respect to the special rights and privileges granted.
ISSUANCE OF CAPITAL STOCK
Stocks issued may have
 Par value
 No par value but stated value
  No par value and no stated value
Stock may also be issued:
 At par- when a stock is issued at the same amount of par value
 At premium or
 At discount
1. Issuing Common Stock at par
This is when a stock is issued at the same amount of par
Eg: Suppose WOW corporation issues 500 shares of its Br. 10 par common stock for
cash equal to its par value. The stock issuance entry is:
Jan. 10 Cash (500 x Br. 10)……………………5000
Common stock ……………………………..5000
(To record the issuance of common stock at par)
The amount invested in the corporation is called paid-in capital or contributed capital. The
credit to common stock records an increase in paid-in capital of the corporation.
2. Issuing Common Stock at a Premium
A corporation usually issues its common stock for a price above par value. The excess
amount which is above par is called a premium.
Eg; Assume WOW corporation issues 4,000 shares of it’s at Br. 10 par common stock for a
price of Br. 25 per share. The entry to record the issuance of the stock is:
Jan. 15 Cash (4000 x Br. 25) …………………………………….. 100,000
Common stock (4000xBr.10)…………………………. 40,000
Paid in capital in excess of par-common (4000x Br.15)…. 60,000
(To record issue of common stock at premium)
A premium on the sale of stock is not gain; income or profit to the corporation because the
entry is dealing with its own stockholders. This illustrates one of the fundamentals of
accounting: a corporation can’t earn a profit, nor can it incur a loss, when it sells its stock or
buys stock from its own stockholders.
STOCKKHOLDERS’ EQUITY
The stockholders section of a corporation’s balance sheet has the following feature:
Paid-in capital:
Common stock, Br. 10 par, 20,000 shares authorized, 4500 share issued -----$ 45,000
Paid-in capital in excess of par --------------------------------------------------- 60,000
Total paid in capital ------------------------------------------------------------------ 105,000
Retained earnings --------------------------------------------------------------------------- 85,000
Total stockholders’ equity----------------------------------------------------------------- $190.000
Since both par value and premium amounts increase the corporation’s capital, they appear in
the stockholder’s equity section of the balance sheet.
3. Issuing Common Stock at a Discount
Stock issued at a price below par is said to be issued at a discount.
Eg: Assume a corporation issued 1000 shares of Br. 5 par common stock for Br. 3 per share.
The entry to record the issuance:
Feb. 15 Cash (1000xBr. 3) ……………………………… . 3000
Discount on common stock (1000 x 2) ……………..2000
Common stock (1000 x 5) …………………………….5000
(To issue common stock at a discount.)
The discount is reported in the stockholders’ equity section of the balance sheet immediately
after the stock account (as just shown for reporting a premium). However, the discount,
because it has a debit balance, is subtracted from the credit balance par value of the stock
issued to figure the capital amount.
The issuance of stock at a discount is rare. In fact, it is illegal in most states. When stock is
sold at a discount, the stockholder has a contingent liability for the discount amount. If the
corporation later liquidates, its creditors can require the original stockholder to pay the
discount amount.
ISSUING NO PAR COMMON STOCK
The contingent liability on common stock issued at a discount may explain why some state
laws allow companies to issue no par stock. If the stock has no par value, there can be no
discount and thus no contingent liability.
Eg; Assume a corp. issues 300 shares of no par common stock for Br. 20 per share. The
stock issuance entry is
May 10. Cash (300 x 20) ………………………6000
Common stock ………………………….6000
(To issue no par common stock.)
Issuing No-Par Common Stock with a Stated Value
Accounting for no-par stock with a stated value is identical to accounting for par value stock.
The premium account for no-par common stock is entitled “paid-in capital in excess of stated
value - common.”
Cash……………………………………………………xxx
Common stock …………………………………………….xxx
Common stock in excess of stated value common ………..xxx
Capital stock may be issued or sold:
 For cash:
 For non cash assets
 Through subscription.
Issuing Common Stock for Assets Other than Cash
Stocks may be issued:
 For services (compensation to attorneys, consultants, and
other), or
 For non- cash assets (land, building and equipment)
To illustrate, assume that the attorney for Compact Incorporation, agree to accept 4,000
shares of Br 1 par value common stock in payment of their bill of Br 5,000 for service
performed in helping the corporation to incorporate. At the time of the exchange, there is no
established market price for the stock.
Jan. 5. Organization Costs 5,000
Common stock (par)
4,000
Paid in capital in excess of par value
1,000
(To record issuance of 4000 shares of Br 1 per value stock to
attorney)
Assume that Rainbow Incorporation is a public held corporation whose Br 5 par value stock
is actively traded at Br 8 per share. The Co. issues 10,000 shares of stock to acquire land
recently advertised for sale at Br 90,000. The transaction is recorded as follows:

April 18. Land 80,000

Common stock 50,000
Paid- in capital in excess of per value 30,000
(To record issuance of 10,000 share of Br 5 per value stock for land)
When a corporation issues capital stock in exchange for services or for assets other than cash,
the transaction should be recorded at the current market value of the goods or services
received, or at the market value of the share, whichever is more clearly determinable.
Issuing Common Stock through subscriptions
A stock subscription is a contract in which the investor agreed to pay the subscription price at
a future date or in a series of installment. The subscriber receives no shares until he/she pay
the contract price in full. The subscriber normally makes a down payment when he/she signs
the subscription contract; the balance is paid in installment.
Assume a corporation receives a subscription on Jan. 30 for 5,000 shares of Br 10 par
common stock. The subscription price is Br 18 per share. A 20 % down payment is received
at the time the subscription contract is signed. The remainder is due in two equal installments
on Mar. 1 and Apr. 1, 2003. The corporation will issue the stock when the subscriber pays in
full. The entry to record the receipt of the subscription is:
Jan. 30. Cash 18,000
Stock subscription receivable- common 72,000
Common stock subscribed (5000 x Br 10) 50,000
Paid in capital in excess of per- common (5000 x Br 8) 40,000
(To record the sale of subscription to 5,000 shares of Br 10 per
capital at Br 8 and the receipt of 20% down payment )
The entries to record receipt of the two installments and issuance of the
stock are:

May 1. Cash 36,000

Stock subscriptions receivable- common 36,000
(To record receipt of first instalment on common stock subscription)
April 1. Cash 36,000
Stock subscriptions receivable- common 36,000
(To collect second instalment on common stock subscription)
When the subscription price is paid in full, the stock is issued by the following entry:
April 1. Common stock subscribed 50,000
Common stock 50,000
(To record the issuance of 5000 shares of Br. 10 par commons stock under subs.)
The last entry is needed to transfer the par value of the stock from the subscribed account to
common stock.
Issuing Preferred Stock
Accounting for preferred stock follows the same pattern as illustrated for common
stock.
Assume the Wow Corporation’s charter authorizes issuance of shares of 5%, Br.100
par preferred stock. On Feb. 1 the corporation issues 400 shares at a price of Br 110.
The issuance entry is:
Feb.1Cash (400xBr110) 44,000
Preferred stock (400x Br 100) 40,000
Paid in capital in excess of par - preferred (400x br10) 4,000
(To issue preferred stock at a premium)
Like that of a Common stock preferred stock often sells at its par value or at a premium but
seldom at a discount. Accounting for no-par preferred stock follow the same pattern
illustrated for no par common stock.

Donated Capital
Donated Capital results when a corporation receives assets as a result of a gift or donation
from municipalities, charitable foundations, or other sources. Corporation occasionally
receives gifts or donations either in the form of cash or other assets. For example, City
council members may offer a corporation free land to encourage it to locate in their city with
the belief that the existence of the corporation will increase local employment.
Suppose Wow Corporation receives 100 hectare of land as a donation from the city
municipality. The current market value of the land is Br 150,000. The receipt of donation is
recorded as follows.
June 1. Land 150,000
Donation Capital 150,000
(To record donation of land from the city)
Donated capital is classified as part of paid-in capital in the stockholders’ equity section of
the balance sheet.
Dividends on Preferred and common Stock
Definition: dividend is a distribution of earnings of a corporation to its shareholders in return
for their investment. The amount of dividend to be distributed may be
expressed either in a percentage or specified amount.

Example- 10 % or $ 100 per preferred stock

A corporation must declare a dividend before paying it. The board of director alone has the
authority to declare a dividend. The corporation has no obligation to pay a dividend until the
board declares, but once declared, the dividend becomes a legal liability of the corporation.
Assume Moon Light Corporation has the following classes of stock in its balance sheet on
Dec. 31, 2001.
8 % preferred stock, Br 50 par 10,000 shares authorized, 2,000
Shares issued and outstanding Br. 100,000
Common stock, Br 10 par 100,000 shares authorized, 50,000
Shares issued and outstanding 500,000
Total preferred and common stock 600,000
 If the board of the corporation declares annual cash dividend of Br 150,000, what is the
amount of dividend to be allocated (paid) to each class of stock assuming the preferred
stock is non-cumulative and non-participative?
Preferred (8%x Br 50x 2,000 shares) Br. 8,000
Common (remainder: Br 150,000-Br 8,000) 142,000
Total dividend 150,000

To an investor, the preferred stock is safer because it receives dividend first. That is, the
common stockholders will receive only the remaining amount after preferred stockholders
obtain first. However, the earning potential from an investment in common stock is much
greater than from an investment in preferred stock. Preferred dividends are usually
limited to the specified amount, but there is no upper limit on the amount of common
dividends.
Classification of Preferred Shares
a) Cumulative but Non- Participative
Cumulative dividend feature offers preferred stockholders the right to receive both current –
year dividends and unpaid prior-year(s) dividends (called dividends in arrears) before
common stockholders receive any dividends. If the preferred stock is non cumulative, the
corporation is not obligated to pay dividends inarrears. Dividends in arrears are not
considered as a liability, because no obligation exists until the Board of Directors declares the
dividend.
Suppose in the previous example the preferred stock is cumulative, non-participating feature
and the corporation did not declare or pay dividend during 1999 and 2000, the allocation of
dividends will be determined as follows:
Preferred Common Total
Total outstanding stock (par) Br 100,000 Br. 500,000 Br. 600,000
Total dividend declared 150,000
First, Preferred dividend in arrears
(8%x Br 50x 2,000 sh. x 2yrs) 16,000 (16,000)
Amount remaining Br. 134,000
Second, regular current preferred div.
(8%xBr 50 x 2000 share) 8,000 (8,000)
Amount remaining Br. 126,000
Third ,remaining allocated to common 126,000 (126000)
Amount remaining -0-
Total distribution 24,000 + 126,000 = Br 150,000
b) Cumulative & Participating
Participating dividend feature gives preferred stockholders the right to receive dividend
beyond the specified rate (amount) by sharing proportionally with common stockholders for
any remaining amount. If, however, the preferred divided is limited to the specified rate
(amount) the stock is referred to as non-participating.
Example :- Suppose in the previous example the board of the corporation declares annual
cash dividend of Br 154,000 and the preferred stock is both cumulative and participating and
the corporation did not declare dividends during 1999 and 2000. The amount of dividend for
each class at the end of 2001 is determined as follows:
 Preferred Common Total
Total Outstanding stock (par) Br. 100,000 Br. 500,000 Br. 600,000
Total Dividend Declared 154,000
First, Preferred dividends in arrears
(8% x Br. 50 x 2,000sh x 2yrs) 16,000 (16,000)

Amount Remaining Br. 138,000

Second, regular current preferred dividends

(8% x Br. 50 x 2,000sh) 8,000 ( 8,000)

Amount Remaining Br. 130,000

Third, Common dividend

(8% x Br.10 x 50,000sh) 40,000 (40,000)

Amount Remaining 90,000

Fourth , remainder allocated each the same

Percentage (90,000 /600,000=15%)

15% x Br. 100,000 15,000 ( 15,000 )

15% x Br. 500,000 _____ 75,000 ( 75,000 )

Amount Remaining Br. -0-

Total Distribution 39,000 115,000 154,000

Participating preferred stock is rare. In fact, preferred stock is non-participating unless it is
specifically described as participating on the stock certificate and in the financial statements.
Treasury stock
Definition- Treasury stock is a corporation’s own stock that has been issued, fully paid for,
and acquired by the issuing corporation, but not re-issued.
Treasury stock is still consider issued but not outstanding and, therefore, is not included in
computing earning per share and does not received dividend.
The difference between an issued stock and treasury stock is that treasury stock has been
issued and bought back. Treasury share are issued, but are not outstanding because they are
no longer in the hand of stockholders. The purchase of treasury stock decreases the
cooperation’s asset and its stockholder’s equity. The purchase of treasury stock is usually
recorded at cost in a treasury stock account.
Reasons for reacquisition
 To make stocks available to issue to officers and employees under bonus plan
 To support the stock’s current market price by decreasing the supply of stock
available to the public.
 To increase earnings per share by reducing the number of shares outstanding.
  To avoid a takeover by an outside party.
The stockholder’s equity section before the purchase of treasury stock is as follows.
Paid-in capital :
Common stock, Br. 1 par , 10,000 shares authorized, 8,000 shares
issued and outstanding Br. 8,000
paid-in capital in excess of par-common 12,000
Total paid-in capital 20,000
Retained earnings 14,600
Total stockholder’s equity Br. 34,600
On Sep.10 the corporation purchases 1,000 shares of its Br. 1 par common as treasury stock,
paying cash of Br. 7.50 per share.
The corporation records the purchase as follows:
Sept. 10. Treasury stock-common (1,000 x Br.7.50) 7, 500
Cash 7,500

(To record purchase of 1,000 share of treasury-stock at Br. 7.5per share)

Treasure stock is recorded at cost, with out reference to the par value of the stock. The
treasury stock account is reported below retained earnings on the balance sheet, and its
balance is subtracted from the sum of total paid-in capital and Retained Earning, as follows:
Paid in capital:

Common stock, Br. 1 per, 10,000 share authorized,

8,000 shares issued, 7000 share outstanding Br. 8,000

paid in capital in excess of per-common 12,000

Total paid-in capital 20,000

Retained earnings 14,600

Total paid-in capital and retained earnings 34,600

Less: Treasury stock (1,000shares at cost) (7,500)

Total stockholder’s equity Br. 27,100

Observe that the purchase of treasury stock does not decrease the number of shares issued.
The common stock, paid-in capital in excess of par, and R/Earning account remain
unchanged.
However, total stockholders’ equity decreases by the cost of the treasury stock. Also, share of
outstanding decrease from 8,000 to 7,000.
Only outstanding shares have the right to vote, receive cash dividends, and share in asset if
the corporation liquidates.
While shares are hold in the treasury, they don’t possess the right of outstanding shares-they
can’t vote or receive dividends.
Re-issuance or sale of Treasury stock

Treasury stock is usually reissued or sold at its purchased cost, above its cost or below its
cost.
A) Sale of Treasury stock at cost –treasury stock may be sold at any price agreeable to
the corporation and the purchaser. If the stock is sold for the same price that the
cooperation paid to reacquire it, the entry is a debit to cash and a credit to Treasury
stock for the same amount.
Cash xxx
Treasury stock xxx
B) Sale of Treasure stock above cost – If the sale is greater than reacquisition cost, the
d/c is credited to the account paid-in capital from treasury stock.
Suppose in the previous e.g. the co. resold 200 of its treasury shares for Br. 9 per share, the
entry is
Dec.10. Cash (200 sh. x Br.9) 1800
Treasury stock, common (200sh x Br.7.50) 1500
Paid-in capital from treasury stock 300

(To sell 200 share of treasury stock at Br.9per share)

The Br. 300 credit in the entry is not made to Gain on sale of Treasury stock for two reasons:
1. Gains on sales occur when assets are sold and treasury stock is not an asset.
2. A corporation does not realize a gain or suffer a loss from stock transactions with its
own stockholders.
C) Sale of Treasury stock below cost- At times the resale price is less than cost. The
difference between these two amounts is debited to paid-in capital from Treasury. If
the difference between resale price and cost is greater than the credit balance in paid-
in capital from Treasury stock account, then the corporation debits Retained Earnings
for the remaining amounts.
For e.g assume the corporation sold 400 share of treasure stock at Br. 7 per share.
The entry is:
Dec 15. Cash (400 sh x Br 7) 2,800
Paid-in capital from treasury stock (400 sh x Br 0.5) 200
Treasury stock (400 sh x Br 7.5 cost) 3,000
(To record sales of 400 sh. of treasury stock at Br 7)
The sales of treasury stock increase both total assets and total stockholder equity.
Assume, however, that the corporation sold the 400 shares of treasury stock at Br 5 per
share. The entry is:

Dec. 15. Cash (400 sh x Br 5) 2000

Paid in capital from treasury stock 300
Retained earning 700
Treasury stock, common (400 x Br 7.5) 3,000
(To record sales of 400 sh of treasury stock at Br 7)
Reporting of Earning and Dividends
Dividends:

Dividends are distribution of retained earnings of a corporation in the form of cash, stocks, or
other assets.
For a corporation to declare a cash dividend it considers three factors:
1. Retained earnings- Since dividends represents a distribution of earnings to
stockholder, the theoretical maximum for dividends is the total undistributed Net
income of the corporation represented by the credit balance of the Retained Earnings
account.
2. Adequate cash (position):- The fact that the corporation reports large earnings does
not mean that it has a large amount of cash on hand. Cash generated from earnings
may have been invested in new plant and equipment or in paying off debts or in
acquiring a larger inventory.
3. Dividend action by the board of directors: - Eventhough a corporation’s net income
is substantial and its cash position seemingly satisfactory, dividends are not paid
automatically. A formal action by the BOD is necessary to declare Dividends.
Three dates are important in connection with dividends:
1.The declaration date
2.The record date, and
3.The payment date
1. Declaration date-is the day that the BOD announces distribution dividend. The
declaration creates a liability for the corporation.
To illustrate, assume that on De. 1, 1995, the Board of ABC Corporation declared a Br.
0.80 per share cash dividend on 100,000 shares of Br. 10 par value common stock. The
entry to record the declaration is:
Dec.1 Retained Earnings (Br 0.8 x 100,000 sh.) 80,000
Dividend payable 80,000
(To record declaration of cash dividend)
2. Record date-is the day that the list of the names and address of the stockholders is
compiled. The purpose of the record date is to identify the persons or entities that will
receive the dividends, not to determine the amount of the dividend liability. No
accounting entry is necessary on the record date because no further financial
transaction or commitment has taken place.
3. Payment date- is the day on which the dividends are sent to the shareholders. The
payment of the cash dividend is recorded at this time.
Dividend payable 80,000
Cash 80,000
(To record payment of dividend)