Chapter 8 Accounting for Receivables

Transcription

1 Chapter 8 Accounting for Receivables Types of Receivables Receivables: amounts due from individuals and companies that are expected to be collected in cash. 1. Accounts Receivables: amounts owed by customers that result from the sale of goods and services. 2. Notes Receivables: written promise (as evidenced by a formal instrument) for amounts to be received. 3. Other Receivables: nontrade (interest, loans to officers, advances to employees, and income taxes refundable). Accounts Receivables 1. Recognizing accounts receivable. Service organization: records when it provides service on account. Merchandiser: records at the point of sale of merchandise on account. 2. Valuing accounts receivable: current asset and valuation (net realizable value). Uncollectible Accounts Receivable: sales on account raise the possibility of accounts not being collected. Seller records losses that result from extending credit as Bad Debt Expense. Direct Write-Off Method: bad debt expense will show only actual losses from uncollectibles. This method is not acceptable for financial reporting purposes. Allowance Method: receivable stated at cash (net) realizable value. Shows the estimated amount of claims on customers that the company expects will become uncollectible in the future. - Debit Bad Debt Expense and credit Allowance for Doubtful Accounts (a contra-asset account). - Debit Allowance for Doubtful Accounts and credit Accounts Receivable at the time the specific account is written off as uncollectible.

2 - If there is the Recovery of an Uncollectible Account, Debit Accounts receivable, Credit Allowance for doubtful accounts then Debit Cash Credit Accounts Receivable Estimating the Allowance - Percentage-of-Sales: emphasizes matching of expenses with revenues and adjusting entry to record bad debts disregards the existing balance in Allowance for Doubtful Accounts - Percentage-of-Receivables: Aging the accounts receivable - customer balances are classified by the length of time they have been unpaid. 3. Disposing of accounts receivable: the company might sell receivables for two reasons. First, they may be the only reasonable source of cash and second is that billing and collection are often time-consuming and costly. Sale of receivables Credit card sales Notes Receivable Promissory note: a written promise to pay a specified amount of money on demand or at a definite time and may be used - when individuals and companies lend or borrow money, - when amount of transaction and credit period exceed normal limits, or - in settlement of accounts receivable, Maker: the party making the promise to pay. Payee: the party to whom payment is to be made. Determining the Maturity Date: in counting, omit the date the note is issued but include the due date.

3 Computing Interest = Face value of Note Annual interest rate Time in terms of one year 1. Recognizing notes receivable: record the notes receivable at its face value. 2. Valuing notes receivable: - report short-term notes receivable at their cash (net) realizable value. - estimation of cash realizable value and bad debts expense are done similarly to accounts receivable. - Allowance for Doubtful Accounts is used. 3. Disposing of notes receivable - notes may be held to their maturity date. - maker may default and payee must make an adjustment to the account. - holder speeds up conversion to cash by selling the note receivable. Honor of notes receivable: maker pays it in full at its maturity date. Dishonor of Notes Receivable: not paid in full at maturity and no longer negotiable.

4 Example 1: At December 31, 2013, Cafu Co. reported the following information on its statement of financial position Accounts receivable R$960,000 Less: Allowance for doubtful accounts 70,000 During 2014, the company had the following transactions related to receivables. 1. Sales on account R$3,315, Sales returns and allowances 50, Collections of accounts receivable 2,810, Write-offs of accounts receivable deemed uncollectible 90, Recovery of bad debts previously written off as uncollectible 29,000 Instructions (A) Prepare the journal entries to record each of these five transactions. Assume that no cash discounts were taken the collections of accounts receivable. (b) Enter the January 1,2014, balances in Accounts Receivable and Allowance for Doubtful Accounts, post the entries the accounts (use T-accounts, and determine the balances. (c) Prepare the journal record bad debt for 2014, assuming that an aging of accounts receivable indicates that expected bad debts are R$125,000.

5 Solution: (a) 1. Accounts Receivable... 3,315,000 Sales Revenue... 3,315, Sales Returns and Allowances... 50,000 Accounts Receivable... 50, Cash... 2,810,000 Accounts Receivable... 2,810, Allowance for Doubtful Accounts... 90,000 Accounts Receivable... 90, Accounts Receivable... 29,000 Allowance for Doubtful Accounts... 29,000 Cash... 29,000 Accounts Receivable... 29,000 (b) Bal. 960,000 (1) 3,315,000 (5) 29,000 Accounts Receivable (2) 50,000 (3) 2,810,000 (4) 90,000 (5) 29,000 Allowance for Doubtful Accounts (4) 90,000 Bal. 70,000 (5) 29,000 Bal. 1,325,000 Bal. 9,000 (c) Balance before adjustment [see (b)]... R$ 9,000 Balance needed ,000 Adjustment required... R$116,000 The journal entry would therefore be as follows: Bad Debt Expense ,000 Allowance for Doubtful Accounts ,000

6 Example 2: The following represents selected information taken from a company's aging estimate uncollectible accounts receivable at year-end. Instructions (a) Calculate the total estimated bad debts based on the above information (b) Prepare the year-end adjusting journal entry to record the bad debts using the allowance method and the aged uncollectible accounts receivable determined in (a). Assume the current balance in Allowance for Doubtful Accounts is a CHF1,600 credit. (c) Of the above accounts, CHF1,100 is determined to be specifically uncollectible. Prepare the journal entry to write off the uncollectible accounts. (d) The company subsequently collects CHF700 on a specific account that had previously been determined to be uncollectible in (c). Prepare the journal entry(ies) necessary to restore the account and record the cash collection.

7 Solution: (a) Total estimated bad debts Number of Days Outstanding Total Over 120 Accounts receivable CHF383,00 CHF220,00 CHF90,00 CHF40,00 CHF18,00 CHF15, % uncollectible 1% 3% 5% 8% 10% Estimated Bad debts CHF9,840 CHF2,200 CHF2,700 CHF2,000 CHF1,440 CHF1,500 (b) Bad Debt Expense... 8,240 Allowance for Doubtful Accounts (CHF9,840 CHF1,600)... 8,240 (c) Allowance for Doubtful Accounts... 1,100 Accounts Receivable... 1,100 (d) Accounts Receivable Allowance for Doubtful Accounts Cash Accounts Receivable

8 Example 3: On January 1, 2014, Valdez Company had Accounts Receivable 91 and allowance for Doubtful Accounts S8,100. Valdez Company prepares financial statements annually at December 31. During the year, the following selected transactions occurred Jan. 5 sold $8,400 of merchandise to Patrick Company, terms n/30 Feb. 2 Accepted an $8,400, 4-month, 10% promissory note from Patrick Company for the balance due. 12 Sold $13,500 of merchandise to Marguerite Company and accepted Margue- rite's $13,500, 2-month, 10% note for the balance due. 26 Sold $7,000 of merchandise to Felton Co., terms n/10 Apr. 5 Accepted a $7,000, 3-month, 8% note from Felton Co. for the balance due. 12 Collected Marguerite Company note in full June 2 Collected Patrick Company note in full. July 5 Felton Co. dishonors its note of April 5. It is expected that Felton will eventually pay the amount owed. 15 Sold $14,000 of merchandise to Planke Co. and accepted Plankes $14,000 3-month, 12% note for the amount due. Oct. 15 Planke Co.'s note was dishonored. Planke Co. is bankrupt, and there is no hope of future settlement. Instructions: Journalize the transactions

9 Solution: Jan. 5 Accounts Receivable Patrick Company... 8,400 Sales Revenue... 8,400 Feb. 2 Notes Receivable... 8,400 Accounts Receivable Patrick Company... 8, Notes Receivable... 13,500 Sales Revenue... 13, Accounts Receivable Felton Co.... 7,000 Sales Revenue... 7,000 Apr. 5 Notes Receivable... 7,000 Accounts Receivable Felton Co.... 7, Cash ($13,500 + $225)... 13,725 Notes Receivable... 13,500 Interest Revenue ($13,500 X 10% X 2/12) June 2 Cash ($8,400 + $280)... 8,680 Notes Receivable... 8,400 Interest Revenue ($8,400 X 10% X 4/12) July 5 Accounts Receivable Felton Co. ($7,000 + $140)... 7,140 Notes Receivable... 7,000 Interest Revenue ($7,000 X 8% X 3/12) Notes Receivable... 14,000 Sales Revenue... 14,000 Oct. 15 Allowance for Doubtful Accounts... 14,000 Notes Receivable... 14,000

10 Chapter 9 Plant Assets, Natural resources and Intangible Assets PLANT ASSETS Plant assets are tangible resources that are used in the operations of a business and are not intended for sale to customers. Plant assets are subdivided into four classes: 1 Land 2 Land improvements 3 Buildings 4 Equipment DETERMINING THE COST OF PLANT ASSETS Plant assets are recorded at cost in accordance with the cost principle. Cost consists of all expenditures necessary to acquire the asset and make it ready for its intended use. These costs include purchase price, freight costs, and installation costs. LAND The cost of Land includes: 1 cash purchase price 2 closing costs such as title and attorney s fees 3 real estate brokers commissions 4 accrued property taxes and other liens on the land assumed by the purchaser. All necessary costs incurred in making land ready for its intended use are debited to the Land account. LAND IMPROVEMENTS The cost of land improvements includes all expenditures necessary to make the improvements ready for their intended use such as:

11 1 parking lots, paving 2 fencing, and 3 lighting BUILDINGS The cost of buildings includes all necessary expenditures relating to the purchase or construction of a building. When a building is purchased, such costs include the purchase price, closing costs, and real estate broker s commission. Costs to make the building ready for its intended use consist of expenditures for remodeling and replacing or repairing the roof, floors, wiring, and plumbing. When a new building is constructed, cost consists of the contract price plus payments for architects fees, building permits and excavation costs. EQUIPMENT The cost of equipment consists of the cash purchase price, sales taxes, freight charges, and insurance paid by the purchaser during transit. Cost includes all expenditures required in assembling, installing, and testing the unit. Recurring costs such as licenses and insurance are expensed as incurred. EXPENDITURES DURING USEFUL LIFE Ordinary repairs are expenditures to maintain the operating efficiency and expected productive life of the plant asset. They are debited to Repairs Expense as incurred and are often referred to as revenue expenditures. Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life of the plant asset. 1 These expenditures are usually material in amount and occur infrequently during the period of ownership. 2 Since additions and improvements increase the company s investment in productive facilities, they are debits to the plant asset affected, and are referred to as capital expenditures.

12 1. Computation of total cost of plant and equipment a. Land Total cost of land =Purchase price + Costs of survey, tax, legal fees, land fill, clearing, commission + cost of old building (meant for demolition) + cost of demolition of old building (excavation of old building) cash received on sale of scrap of old building + accrued real estate tax paid on purchase of land b. Total cost of land improvement = Cost of streets, sidewalks + cost of fence, walls + drainage, sewers + cost of plants + parking lots + drive ways, etc. c. Total cost of building = Contract price + Architect fees + Insurance premium paid on construction + Interest paid on money borrowed for construction + cost of excavation for new building + any other expense on building d. Total cost of machinery and equipment = purchase price + sales tax + Testing fees + Installation cost + Transportation cost under FOB shipping point + repairing cost on purchase (before using the asset) + any other expense on purchase + cost of painting and lettering + insurance during shipping Note: 1) If the transportation cost is FOB destination, it should not be added to the cost of asset. 2) Insurance we pay every year is prepaid insurance and real estate tax we pay every year is tax expense. Ex.1 Cost of land $15000 Cost of old building $5000 Legal fees on purchase for land $800 Cost of excavation - old building $200 Sale of scrap - old building $400 Cost of Land = = $20600 Cost of building = 0

13 2. Disposal of an asset Point to remember : 1) On the date of disposal the book value of the asset must be computed. So total accumulated depreciation is up to the date of disposal. (Compute depreciation on the date of disposal) 2) On disposal, cancel asset account by crediting asset account and cancel accumulated depreciation a/c by debiting accumulated depreciation account. Methods of disposal I. Discard (Retirement) II. III. Sell Exchange I. (Retirement) Abandon the asset ; so book value is loss. II. Accumulated depreciation Loss on disposal (BV) Asset (total) Sale journal entry Accumulated depreciation Cash Asset (full value) Dr. Dr. Dr. Cr. Dr. Cr. Note 1) Any loss - Debit loss on disposal Any gain - Credit gain on disposal 2) Loss/gain = selling price book value (If selling price is more than BV, then gain)

14 III. Exchange. Getting a similar asset by exchanging the old asset Journal entry Accumulated depreciation (old asset) Asset (new) Loss on disposal Asset (old) Cash Gain on disposal Dr. Dr. Dr. Cr. Cr. Cr. Note : gain loss on exchange = Fair market value book value (If market value is more than BV, then gain) Cost of new asset = Fair market value + Cash paid 3. Natural Resources: ex. Coal mine, Iron ore mine, Oil fields etc. (What we get from the earth) Loss of value is depletion expense: (follow unit of activity method to compute) Journal entry Depletion expense Dr. Accumulated depreciation (asset name) Cr. 4. Intangible asset. These are assets without any physical existence (invisible) Ex; Patent, copyright etc. If life of intangible asset is given, then it should be amortized. Loss of value is Amortization expense. (follow straight line method to compute) Amortization expense Asset Dr. Cr.

15 Ex. July 5, 2006 purchased a coal mine for $40000 and a patent for $ The mine contains tons of coal and salvage value $5000. Useful life of patent 10 years and no salvage value show journal entries on July 5 and Dec 31, (5000 tons of coal were extracted in 2006) July 5, 2006 Dec 31, 2006 Coal mine Cash Patent Cash Depletion expense Coal mine 1750 Accumulated depreciation Coal mine {( ) 10000}x Amortization expense - Patent 500 Patent { }x{6 12} 500 Example Diaz Company was organized on January 1. During the first year of operational, the following plant asset expenditures and receipts were recorded in random order. Debit 1. Cost of filling and grading the land $ Full payment to building contractor Real estate taxes on land paid for the current year Cost of real estate purchased as a plant site (land$ and building $45000) 5. Excavation costs for new building Architect s fees on building plans Accrued real estate taxes paid at time of purchase 2000 of real estate 8. Cost of parking lots and driveways Cost of demolishing building to make land suitable for construction of new building $

16 Credit 10. Proceeds from salvage of demolished building $ 3600 =>Analyze the foregoing transactions using the following column headings. Insert the number of each transaction in the Item column, and insert the amounts in the appropriate columns. For amounts entered in the other accounts column, also indicate the account titles.<item, Land, Buildings, other accounts> Item Land Buildings Other Accounts ($ 6,000) ( 145,000) ( 2,000) ( 15,000) (3,600) (($ 164,400) ($ 780,000 35,000 10,000 ($ 825,000 ($ 5,000 Property Taxes Expense 14,000 Land Improvements

17 Chapter 10 Liabilities Current Liabilities Current liability is debt with two key features: 1. Company expects to pay the debt from existing current assets or through the creation of other current liabilities. 2. Company will pay the debt within one year or the operating cycle, whichever is longer. Current liabilities include notes payable, accounts payable, unearned revenues, and accrued liabilities such as taxes payable, salaries payable, and interest payable.

18 Notes Payable Written promissory note. Require the borrower to pay interest. Issued for varying periods. Sales Tax Payable Sales taxes are expressed as a stated percentage of the sales price. Either rung up separately or included in total receipts. Retailer collects tax from the customer. Retailer remits the collections to the state s department of revenue. Example The March 25 cash register reading for Cooley Grocery shows sales of $10,000 and sales taxes of $600 (sales tax rate of 6%), the journal entry is: Cash 10,600 Sales 10,000 Sales tax payable 600 Unearned Revenue Revenues that are received before the company delivers goods or provides services. 1. Company debits Cash, and credits a current liability account (unearned revenue). 2. When the company earns the revenue, it debits the Unearned Revenue account, and credits a revenue account. Current Maturities of Long-Term Debt Portion of long-term debt that comes due in the current year. No adjusting entry required.

19 Analysis Liquidity refers to the ability to pay maturing obligations and meet unexpected needs for cash. The current ratio permits us to compare the liquidity of different-sized companies and of a single company at different times. Non-Current Liabilities Bond Basics Bonds are a form of interest-bearing notes payable. Bonds are issued by a company to obtain large amounts of long term capital. In authorizing the bond issue the board of directors must stipulate 1 the total number of bonds to be authorized, total face value, and 2 the contractual interest rate The company pays interest to the investors on a periodic basis. Types of Bonds Secured and Unsecured (debenture) bonds. Term and Serial bonds. Registered and Bearer (or coupon) bonds. Convertible and Callable bonds.

20 Issuing Procedures Bond contract known as a bond indenture. The terms of the bond issue are set forth in a legal document called a bond indenture. It shows the terms and rights of the bondholders. Represents a promise to pay: (1) sum of money at designated maturity date, plus (2) periodic interest at a contractual interest rate. Bond certificate, typically a $1,000 face value. Interest payments usually made semiannually, usually, January 1 and July Bond Trading Bonds traded on national securities exchanges. Newspapers and the financial press publish bond prices and trading activity daily. Determining the Market Value of Bonds Market value is a function of the three factors that determine present value: 1. dollar amounts to be received, 2. length of time until the amounts are received, and 3. market rate of interest. The features of a bond (callable, convertible, and so on) affect the market rate of the bond. Issuing Bonds at Face Value Illustration: On January 1, 2011, CandlestickCorporation issues $100,000, fiveyear, 10% bonds at 100 (100% of face value). The entry to record the sale is: Jan. 1 Cash 100,000 Bonds payable 100,00

21 Illustration: On January 1, 2011, Candlestick Corporation issues $100,000, five-year, 10% bonds at 100 (100% of face value). Assume that interest is payable semiannually on January 1 and July 1. Prepare the entry to record the payment of interest on July 1, 2011, assume no previous accrual. July 1 Interest expense 5,000 Cash 5,000 Illustration: On January 1, 2011, CandlestickCorporation issues $100,000, fiveyear, 10% bonds at 100 (100% of face value). Assume that interest ispayable semiannually on January 1 and July 1. Prepare the entry to record the accrual of interest on December 31, 2011, assume no previous accrual. Dec. 31 Interest expense 5,000 Interest payable 5,000 Issuing Bonds at a Discount Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $92,639 (92.639% of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1 Cash 92,639 Bond payable 92,639 Issuing Bonds at a Premium Illustration: On January 1, 2011, Candlestick, Inc. sells $100,000, five-year, 10% bonds for $108,111 ( % of face value). Interest is payable on July 1 and January 1. The entry to record the issuance is: Jan. 1 Cash 108,111 Bonds payable 108,111 Redeeming Bonds at Maturity Assuming that the company pays and records separately the interest for the last interest period, Candlestick records the redemption of its bonds at maturity as follows: Bond payable 100,000 Cash 100,000

22 Redeeming Bonds before Maturity When retiring bonds before maturity, it is necessary to: 1. eliminate the carrying value of the bonds at the redemption date; 2. record the cash paid; and 3. recognize the gain or loss on redemption. The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date. Long-Term Notes Payable May be secured by a mortgage that pledges title to specific assets as security for a loan. Typically, terms require the borrower to make installment payments over the term of the loan. Payment consists of 1. interest on the unpaid balance of the loan and 2. a reduction of loan principal. Companies initially record mortgage notes payable at face value. Amortizing Bond Discount Bond Discount Number of Interest Periods = Bond Discount Amortize

23 Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $92,639 (discount of $7,361). Interest is payable on July 1 and January 1. The bond discount amortization for each interest period is $736 ($7,361/10). Journal entry on July 1, 2011, to record the interest payment and amortization of discount is as follows: July 1 Interest Expense 5,736 Bonds Payable 736 Cash 5,000 Bond Discount Amortization Table Semi-annual Interest to Interest Exp to Discount Bond interest be paid be recorded Amortization carrying value Issue date 92, ,000 5, , ,000 5, , ,000 5, , ,000 5, , ,000 5, , ,000 5, , ,000 5, , ,000 5, , ,000 5, , ,000 5, ,000

24 Amortizing Bond Premium Bond Premium Number of Interest Periods = Bond Premium Amortize Candlestick, Inc., sold $100,000, five-year, 10% bonds on January 1, 2011, for $108,111 (premium of $8,111). Interest is payable on July 1 and January 1. The bond premium amortization for each interest period is $811 ($8,111/10). Journal entry on July 1, 2011, to record the interest payment and amortization of premium is as follows: July 1 Interest Expense 4,189 Bonds Payable 811 Cash 5,000 Ex. Zhu Company issues HK$3 million, 10-year, 9% bonds at 96, with interest payable on July 1 and January 1. The straight-line method is used to amortize bond discount. (a) Prepare the journal entry to record the sale of these bonds on January 1, (b) Prepare the journal entry to record interest expense and bond discount amortization on July 1, 2014, assuming no previous accrual of interest. Solution (a) Jan. 1 Cash (.96 X HK$3,000,000)... 2,880,000 Bonds Payable... 2,880,000 (b) July 1 Interest Expense ,000 Bonds Payable (HK$120,000 20)... 6,000 Cash (HK$3,000,000 X 9% X 1/2) ,000

25 Ex. Allman Inc. issues $2 million, 5-year, 10% bonds at 102, with interest payable on July 1 and January 1. The straight-line method is used to amortize bond premium. (a) Prepare the journal entry to record the sale of these bonds on January 1, (b) Prepare the journal entry to record interest expense and bond premium amortization on July 1, 2014, assuming no previous accrual of interest. Solution (a) Cash (1.02 X $2,000,000)... 2,040,000 Bonds Payable... 2,040,000 (b) Interest Expense... 96,000 Bonds Payable ($40,000 10)... 4,000 Cash ($2,000,000 X 10% X 1/2) ,000 Ex. On January 1, Payne Company issued $200,000, 8%, 10-year bonds at face value interest is payable semiannually on July 1 and January 1. Instructions (a)the issuance of the bonds. (c) The payment of interest on July 1, assuming that interest was not accrued on June 30. (d) The accrual of interest on December 31. Solution (a) Jan. 1 Cash ,000 Bonds Payable ,000 (b) July 1 Interest Expense... 8,000 Cash ($200,000 X 8% X 1/2)... 8,000 (c) Dec. 31 Interest Expense... 8,000 Interest Payable... 8,000

26 Ex. Booker Co. sold R$300,000, 10 %, 10 year- bonds on January 1,2014. The bond were dated January 1, and interest is paid on January 1 and July 1. The bonds were sold at 104. Instructions (a) 1, (b) Prepare the journal entry to record the issuance of the bonds on January At December 31,2104, the amount of unamortized bond premium is R$10,800. Show the statement of financial position presentation of accrued interest and the bond liability at December 31,2014. (c) On January 1,2016, when the carrying value of the bonds was R$309,600, the company redeemed the bonds at 105. Record the redemption of the bonds assuming that interest for the period has already been paid. Solution (a) 2014 Jan. 1 Cash (R$300,000 X 1.04) ,000 Bonds Payable ,000 (b) Non-current Liabilities Bond payable, due R$310,800 Current Liabilities Interest payable (R$300,000 X 10% X 1/2)... R$ 15,000 (c) 2016 Jan. 1 Bonds Payable ,600 Loss on Bond Redemption... 5,400* Cash (R$300,000 X 1.05) ,000 *(R$315,000 R$309,600)

27 Chapter 11 Corporations: Organization, Share, Transactions, Dividends, and Retained Earnings The Corporate Form of Organization A corporation is an entity separate and distinct from its owners. Two common ways to classify corporations are by purpose and by ownership. A corporation may be organized for the purpose of making a profit, or it may be not-for-profit. Classification by ownership differentiates publicly held and privately held corporations. A publicly held corporation may have thousands of shareholders. Its shares are regularly traded on a national securities exchange. A privately held corporation usually has only a few shareholders, and does not offer its shares for sale to the general public. Privately held companies are generally much smaller than publicly held companies. ᛥ Characteristics of a Corporation Characteristics that distinguish corporations from proprietorships and partnerships. o Separate Legal Existence: The corporation acts under its own name rather than in the name of its shareholders. o Limited Liability of Shareholders: The liability of shareholders is normally limited to their investment in the corporation. o Transferable Ownership Rights: Ordinary shares give ownership in a corporation. These shares are transferable units. o Ability to Acquire Capital: Corporation can obtain capital through the issuance of shares. o Continuous Life: Continuance as a going concern is not affected by the withdrawal, death, or incapacity of a shareholder, employee, or officer. o Corporation Management: Separation of ownership and management prevents owners from having an active role in managing the company. o Government Regulations: Government regulations are designed to protect the owners of the corporation.

28 o Additional Taxes: Corporations pay income taxes as a separate legal entity and in addition, shareholders pay taxes on cash dividends. ᛥ Forming a Corporation o File application with governmental agency in the jurisdiction in which incorporation is desired. o Government grants charter. o Corporation develops by-laws. o Charter is an approved copy of the application form. Charter creates the corporation. o By-laws establish the rules and procedures for conducting the affairs of the corporation. Corporations expense organization costs as incurred. ᛥ Ownership Rights of Shareholders Shareholders have the right to: 1. Vote in election of board of directors and on actions that require shareholder approval. 2. Share the corporate earnings through receipt of dividends.

29 3. Keep the same percentage ownership when new shares of share are issued (preemptive right). 4. Share in assets upon liquidation in proportion to their holdings. This is called a residual claim. ᛥ Share Issue Considerations Authorized Shares The charter indicates that the amount of shares that a corporation is authorized to sell. The number of authorized shares is often reported in the equity section. Issuance of Shares Corporation can issue shares directly to investors or indirectly through an investment banking firm. Factors in setting price for a new issue of shares: The company s anticipated future earnings Its expected dividend rate per share Its current financial position The current state of the economy The current state of the securities market Market Value of Shares Shares of publicly held companies are traded on organized exchanges.

30 Interaction between buyers and sellers determines the prices per share. Prices set by the marketplace tend to follow the trend of a company s earnings and dividends. Par and No-Par Value Shares Par value shares are ordinary shares to which the charter has assigned a value per share. No-par value shares are ordinary shares to which the charter has not assigned a value. The board of directors assigns a stated value to no-par shares. Accounting for Share Transactions Accounting for Ordinary Share Issues Issuing Par Value Ordinary Shares for Cash 1. Issuing at Par Value ($1) Cash (1,000 x $1) 1,000 Share Capital Ordinary (1,000 x $1) 1, Issuing at more than Par Value ($5) Cash (1,000 x $5) 5,000 Share Capital Ordinary (1,000 x $1) 1,000 Share Premium Ordinary 4,000 Issuing No-Par Ordinary Shares for Cash (stated value) Cash (5,000 x $8) 40,000 Share Capital Ordinary (5,000 x $5) 25,000 Share Premium Ordinary 15,000

31 Issuing Ordinary Shares for Services or Non-Cash Assets Corporations also may issue shares for services (compensation to attorneys or consultants) or for non-cash assets (land, buildings, and equipment). For services Organization Expense 5,000 Share Capital Ordinary (4,000 x $1) 4,000 Share Premium Ordinary 1,000 For non-cash assets Land 80,000 Share Capital Ordinary (10,000 x $5) 50,000 Share Premium Ordinary 30,000 Ex. During its first year of operations, Punjab Corporation had the following transactions pertaining to its ordinary shares. Jan 10 July 1 Issued 70,000 shares for cash at $4 per share. Issued 30,000 shares for cash at $7 per share. Instructions (a) Journalize the transactions, assuming that the ordinary shares have a par value of $4 per share. (b) Journalize the transactions, assuming that the ordinary shares are no-par with a stated value of $1 per share. ANSWER (a) Par Value = $4 per share Jan10: Cash 280,000 Share Capital Ordinary 280,000 July1: Cash 210,000 Share Capital Ordinary 120,000 Share Premium Ordinary 90,000

32 (b) Stated Value = $1 per share Jan10: Cash 280,000 Share Capital Ordinary 70,000 Share Premium Ordinary 210,000 July1: Cash 210,000 Share Capital Ordinary 30,000 Share Premium Ordinary 180,000 Accounting for Preference Shares o Typically, preference shareholders have a priority as to 1. Distributions of earnings (dividends) and 2. Assets in the event of liquidation. o Like ordinary shares, corporations may issue preference shares for cash or for non-cash assets. o Preference shares may have either a par value or no-par value. Ex. Gao Corporation was organized on January 1, It is authorized to issue 10,000 8%, $1,000 par value preference shares, and 500,000 no-par ordinary shares with a stated value of $20 per share. The following share transactions were completed during the first year. Jan. 10 Mar. 1 Apr. 1 Issued 100,000 ordinary shares for cash at $50 per share. Issued 5,000 preference shares for cash at $1,050 per share. Issued 18,000 ordinary shares for land. The asking price of the land was $980,000. The fair value of the land was $920,000. May 1 Aug. 1 Issued 80,000 ordinary shares for cash at $45 per share. Issued 10,000 ordinary shares to attorneys in payment of their bill of $300,000 for service provided in helping the company organize. Sept. 1 Nov. 1 Issued 10,000 ordinary shares for cash $50 per share. Issued 1,000 preference shares for cash at $1,080 per share

33 Instructions (a) Journalize the transactions. (b) Post to the equity accounts. (c) Prepare the share capital section of the statement of financial position at December 31, 2014 ANSWER Preference shares = $1,000 per share Ordinary shares = $20 per share (a) Jan10: Cash 5,000,000 Share Capital Ordinary 2,000,000 Share Premium Ordinary 3,000,000 Mar1: Cash 5,250,000 Share Capital Preference 5,000,000 Share Premium Preference 250,000 Apr1: Land 920,000 Share Capital Ordinary 360,000 Share Premium Ordinary 560,000 May1: Cash 3,600,000 Share Capital Ordinary 1,600,000 Share Premium Ordinary 2,000,000 Aug1: Organization Expense 300,000 Share Capital Ordinary 200,000 Share Premium Ordinary 100,000 Sept1: Cash 500,000 Share Capital Ordinary 200,000 Share Premium Ordinary 300,000

34 Nov1: Cash 1,080,000 Share Capital Preference 1,000,000 Share Premium Preference 80,000 (b) Share Capital Preference Mar1 5,000,000 Nov1 1,000,000 6,000,000 Jan10 2,000,000 Apr1 360,000 May1 1,600,000 Aug1 200,000 Sept1 200,000 4,360,000 Share Premium Preference Mar1 250,000 Nov1 80, ,000 Share Premium Ordinary Jan10 3,000,000 Apr1 560,000 May1 2,000,000 Aug1 100,000 Sept1 300,000 5,960,000 Share Capital Ordinary (c) Gao Corporation Equity Share Capital Preference, 8%, $1,000 par value, 10,000 shares authorized, 6,000 shares issued $ 6,000,000 Share Capital Ordinary, no par, $20 stated value 500,000 shares authorized, 218,000 shares issued 4,360,000 Share Premium Preference 330,000 Share Premium Ordinary 5,960,000 Total Equity $16,650,000

35 Accounting for Treasury Shares Treasury shares are a corporation s own shares that it has issued and subsequently reacquired from shareholders, but not retired. Corporations purchase their outstanding share to: 1. Reissue the shares to officers and employees under bonus and share compensation plans. 2. Enhance the share s market value. 3. Have additional shares available for use in the acquisition of other companies. Purchase of Treasury Shares o The company debits Treasury Shares for the price paid to reacquire the shares. o When the company disposes of the shares, it credits to Treasury Shares the same amount it paid to reacquire the shares. o Treasury Shares is a contra-equity account, so the acquisition of treasury shares reduces equity. Purchase of Treasury Shares (4,000 shares at $8 per share) Jan 1: Treasury Shares 32,000 Cash 32,000 Disposal of Treasury Shares Sale of Treasury Shares above cost price (selling 1,000 shares at $10) Mar 1: Cash 10,000 Treasury Shares 8,000 Share Premium Treasury 2,000 Sale of Treasury Shares below cost price (selling 800 shares at $7) Mar 1: Cash 5,600 Share Premium Treasury 800

36 Treasury Shares 6,400 Ex. Elston Corporation had the following equity accounts on January 1, 2014: Share Capital Ordinary ($5 par) $400,000, Share Premium Ordinary $200,000, and Retained Earnings $100,000. In 2014, the company had the following treasury share transactions. Mar. 10 June 1 Sept. 1 Dec. 1 Purchased 5,000 shares at $9 per share. Sold 500 shares at $12 per share. Sold 2,500 shares at $10 per share. Sold 1,000 shares at $6 per share. Elston Corporation uses the cost method of accounting for treasury shares. In 2014, the company reported net income of $34,000. Instructions (a) Journalize the treasury shares transactions, and prepare the closing entry at December 31, 2014, for net income. (b) Open accounts for (1) Share Premium Treasury, (2) Treasury Shares, and (3) Retained Earnings. Post to the equity accounts. (c) Prepare the equity section for Elston Corporation on December 31, 2014 ANSWER (a) Mar1: Treasury Shares 45,000 Cash 45,000 June1: Cash 6,000 Treasury Shares 4,500 Share Premium Treasury 1,500 Sept1: Cash 25,000 Treasury Shares 22,500 Share Premium Treasury 2,500 Dec1: Cash 6,000 Share Premium Treasury 3,000 Treasury Shares 9,000

37 Dec31: Income Summary 34,000 Retained Earnings 34,000 (b) Share Capital Ordinary Jan1 400, ,000 Share Premium Ordinary Jan1 200, ,000 Treasury Shares Mar1 45,000 Mar1 4,500 Sept1 22,500 9,000 Dec1 9,000 Retained Earnings Jan1 100,000 Dec31 34, ,000 Share Premium Treasury Dec1 3,000 June1 1,500 Sept1 2,500 1,000 (c) Elston Corporation Equity Share Capital Ordinary, $5 par value, 80,000 shares issued and 79,000 shares outstanding $ 400,000 Share Premium Ordinary 200,000 Share Premium Treasury 1,000 Retained Earnings 134,000 Less: Treasury Shares (1,000 shares) 9,000 Total Equity $726,000

38 Ex. The equity accounts of Marya Corporation on January 1, 2014, were as follows. Share Capital Preference (9%, $100 par, cumulative, 5,000 shares authorized) $300,000 Share Capital Ordinary ($3 stated value, 300,000 shares authorized) 660,000 Share Premium Preference 20,000 Share Premium Ordinary 396,000 Retained Earnings 488,000 Treasury Shares Ordinary (5,000 shares) 30,000 During 2014, the corporation had the following transactions and events pertaining to its equity. Feb. 1 Issued 3,000 ordinary shares for $19,500. Mar.20 Purchased 1,500 additional treasury shares (ordinary) at $6 per share. June 14 Sold 4,000 treasury shares (ordinary) for $26,000. Sept. 3 Issued 2,000 ordinary shares for a patent valued at $14,000. Dec. 31 Determined that net income for the year was $350,000. No dividends were declared during the year. Instructions (a) Journalize the transactions and prepare the closing entry for net income. (b) Enter the beginning balances in the accounts and post the journal entries to the equity accounts. (c) Prepare an equity section at December 31, ANSWER (a) Feb1: Cash 19,500 Share Capital Ordinary 9,000 Share Premium Ordinary 10,500 Mar20: Treasury Shares 9,000

39 Cash 9,000 June14: Cash 26,000 Treasury Shares 24,000 Share Premium Treasury 2,000 Sept3: Patent 14,000 Share Capital Ordinary 6,000 Share Premium Ordinary 8,000 Dec31: Income Summary 350,000 Retained Earnings 350,000 (b) Share Capital Preference Jan1 300, ,000 Treasury Shares Jan1 30,000 June14 24,000 Mar20 9,000 15,000 Share Capital Ordinary Jan1 660,000 Feb1 9,000 Sept3 6, ,000 Share Premium Ordinary Jan1 396,000 Feb1 10,500 Sept3 8, ,000 Retained Earnings Jan1 488,000 Dec31 350, ,000 Share Premium Preference Jan1 20,000 20,000 Share Premium Treasury June14 2,000 2,000

40 (c) Marya Corporation Equity Share Capital Preference, 9%, $100 par, 5,000 shares authorized, 3,000 shares issued and outstanding $ 300,000 Share Capital Ordinary, no par, $3 stated value, 300,000 shares authorized, 225,000 shares issued and 222,500 shares outstanding 675,000 Share Premium Preference 20,000 Share Premium Ordinary 414,500 Share Premium Treasury 2,000 Retained Earnings 838,000 Less: Treasury Shares (2,500 shares) 15,000 Total Equity $ 2,437,000 Dividends o A dividend is a corporation s distribution of cash or shares to its shareholders on a pro rata (proportional to ownership) basis. o Pro rata means that if you own 10% of the ordinary shares, you will receive 10% of the dividend. o Dividends can take four forms: cash, property, scrip (a promissory note to pay cash), or shares. Cash Dividends A cash dividend is a pro rata distribution of cash to shareholders. For a corporation to pay a cash dividend, it must have: 1. Retained earnings - Payment of cash dividends from retained earnings is legal in all jurisdictions. 2. Adequate cash. 3. A declaration of dividends by the Board of Directors

41 Dividends require information concerning three dates: Ex. On January 1, Chevon Corporation had 98,000 no-par ordinary shares issued and outstanding. The shares have a stated value of $4 per share. During the year, the following occurred. Apr. 1 June 15 Issued 25,000 additional ordinary shares for $17 per share. Declared a cash dividend of $1 per share to shareholders of record on June 30. July 10 Dec. 1 Dec. 15 Paid the $1 cash dividend. Issued 2,000 additional ordinary shares for $19 per share. Declared a cash dividend on outstanding shares of $1.20 per share to shareholders of record on December 31. Instructions Prepare the entries, if any, on each of the three dividend dates. ANSWER Apr1: Cash 425,000 Share Capital Ordinary 100,000 Share Premium Ordinary 325,000 June15: Cash Dividends (98,000+25,000) x $1 123,000 Dividends Payable 123,000

42 July10: Dividends Payable 123,000 Cash 123,000 Dec1: Cash 38,000 Share Capital Ordinary 8,000 Share Premium Ordinary 30,000 Dec15: Cash Dividends 150,000 Dividends Payable 150,000 Dec31: Retained Earnings 273,000 Cash Dividends 273,000 Share Dividends o A share dividend is a pro rata distribution to shareholders of the corporation s own shares. o Whereas a company pays cash in a cash dividend, a company issues shares in a share dividend. o A share dividend results in a decrease in retained earnings and an increase in share capital and share premium. Unlike a cash dividend, a share dividend does not decrease total equity or total assets.

43 Corporations issue share dividends generally for one or more of the following reasons. 1. To satisfy shareholders dividend expectations without spending cash. 2. To increase the marketability of the corporation s shares. Ex. On January 1, 2014, Lanie Corporation had $1,000,000 of ordinary shares outstanding that were issued at par. It also had retained earnings of $750,000. The company issued 40,000 ordinary shares at par on July 1 and earned net income of $400,000 for the year. Instructions Journalize the declaration of a 15% share dividend on December 10, 2014, for the following independent assumptions. (a) Par value is $8, and market price is $18. (b) Par value is $5, and market price is $20. ANSWER (a) Par value = $8, Market Price = $18 Jan 1: = $1,000,000 8 July 1: = 125,000 shares = 40,000 shares = 165,000 shares x 15% = 24,750 shares Entry: Dec10: Share Dividends (24750 x $18) 445,500 Ordinary share dividends distributable (24750 x $8) 198,000 Share Premium Ordinary 247,500

44 (b) Par value = $5, Market Price = $20 Jan 1: = $10,000,000 5 July 1: = 200,000 shares = 40,000 shares = 240,000 shares x 15% = 36,000 shares Entry: Dec10: Share Dividends (36000 x $20) 720,000 Ordinary share dividends distributable 180,000 Share Premium Ordinary 540,000 Closing Entry Dec 31: Retained Earnings 1,165,500 Share Dividends 1,165,500 Ex. On January 1, 2014, Prasad Corporation had the following equity accounts. Share Capital Ordinary ($25 par value, 48,000 shares issued and outstanding) $1,200,000 Share Premium Ordinary 200,000 Retained Earnings 600,000 During the year, the following transactions occurred. Feb. 1 Declared a $1 cash dividend to shareholders of record on July 15, payable March 1. Mar 1 Paid the dividend declared in February. July 1 Declared a 10% share dividend to shareholders of record on July 15, distributable July 31. On July 1, the market price was $30 per share. July 31 Issued shares for the share dividend.

45 Dec. 1 Declared a $0.40 per share, dividend to shareholders of record on December 15, payable January 5, Dec. 30 Determined that net income for the year was $350,000. Instructions Journalize the transactions and the closing entries for net income and dividends. ANSWER Jan1: = 48,000 shares Feb1: Cash Dividends (48,000 x $1) 48,000 Dividends Payable 48,000 Mar1: Dividends Payable 48,000 Cash 48,000 July1: Share Dividends (4,800 x $30) 144,000 Ordinary share dividends distributable 120,000 Share Premium Ordinary 48,000 July31: Ordinary shares dividends distributable 120,000 Share Capital Ordinary 120,000 Dec1: Cash Dividends (528,000 x $0.4) 21,120 Dividends Payable 21,120 Dec31: Income Summary 350,000 Retained Earnings 350,000 Dec31: Retained Earnings 69,120 Cash Dividends 69,120 Dec31: Retained Earnings 144,000 Share Dividends 144,000

46 Chapter 12 Investments Why corporation invest? Corporations generally invest in debt or share securities for one of three reasons. 1. Corporation may have excess cash. 2. To generate earnings from investment income. 3. For strategic reasons. Accounting for Debt Investments: investment in government and corporation bonds. Recording Acquisition of Bonds: cost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any. Recording Bond Interest: calculate and record interest revenue based upon the carrying value of the bond times the interest rate times the portion of the year the bond is outstanding. Recording Sale of Bonds: credit the investment account for the cost of the bonds and record as a gain or loss any difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the bonds. Accounting for Share Investments: investments in the shares of other corporations. Share investments differs depending on the degree of influence the investor has over the issuing corporation. Holdings Less than 20%, uses cost method. The investment is recorded at cost and revenue is recognized only when cash dividends are received. Holdings between 20% and 50%, uses equity method, record the investment at cost and subsequently adjusts the investment account each period for the investor s share of the associate s net income and dividends received by the investor. Holdings of more than 50%, the ordinary shares is known as the parent company. When holdings more than 50%, consolidated financial statements are usually prepared.

47 Valuation and Reporting of Investments Debt Investment: 1. Trading securities: bought and held primarily for sale in the near term to generate income on short-term price differences. 2. Held-for-collection securities: bought by an investor that had intention and ability to hold to maturity. Share Investment: 1. Trading securities (as mentioned above) 2. Non-trading securities: are held for purpose other than trading. Statement of Financial Position Presentation Short-Term Investments: also called marketable securities, are securities held by a company that are readily marketable and intended to be converted into cash within the next year or operating cycle, whichever is longer. Investments that do not meet both criteria are classified as long-term investments. Presentation of Realized and Unrealized Gain or Loss Other Income and Expense Interest Revenue Dividend Revenue Gain on Sale of Investments Unrealized Gain-Income Loss on Sale of Investments Unrealized Loss-Income

48 Example 1: On December 31, 2013, Ogallala Associates owned the following securities, held as a long-term investment. The securities are not held for influence or control of the investee. Ordinary Shares Shares Cost Carlene Co. 2,000 60,000 Riverdale Co. 5,000 45,000 Raczynski Co. 1,500 30,000 On December 31, 2013, the total fair value of the securities was equal to its cost. In 2014 the following transactions occurred. July 1 Received 1 per share semiannual cash dividend on Riverdale Co. ordinary on shares. Aug. 1 Received 0.50 per share cash dividend on Carlene Co. ordinary shares. Sept. 1 Sold 1,500 ordinary shares of Riverdale Co. for cash at 8 per share. Oct. 1 Sold 800 ordinary shares of Carlene Co. for cash at 33 per share. Nov. 1 Received 1 per share cash dividend on Raczynski Co. ordinary shares. Dec. 15 Received 0.50 per share cash dividend on Carlene Co. ordinary shares 31 Received 1 per share semiannual cash dividend on Rive Co. ordinary shares. At December 31, the fair values per share of the ordinary shares were Carlene Co. 32, Riverdale Co. 8, and Raczynski Co. 18 Instructions (a) Journalize the 2014 transactions and post to the account Share Investments. (Use the T-account form.) (b) Prepare the adjusting entry at December , to show the securities at fair value. The shares should be classified as non-trading securities (c) Show the statement of financial position presentation of the investments at December 31, At this date, Ogallala Associates has share capital ordinary 1,500,000 and retained earnings 1,000,000.

49 Solution: (a) 2014 July 1 Cash (5,000 X 1)... 5,000 Dividend Revenue... 5,000 Aug. 1 Cash (2,000 X 0.50)... 1,000 Dividend Revenue... 1,000 Sept. 1 Cash (1,500 X 8)... 12,000 Loss on Sale of Share Investments ( 13,500 12,000)... 1,500 Share Investments (1,500 X 9)... 13,500 Oct. 1 Cash (800 X 33)... 26,400 Share Investments (800 X 30)... 24,000 Gain on Sale of Share Investments ( 26,400 24,000)... 2,400 Nov. 1 Cash (1,500 X 1)... 1,500 Dividend Revenue... 1,500 Dec. 15 Cash (1,200 X 0.50) Dividend Revenue Cash (3,500 X 1)... 3,500 Dividend Revenue... 3, Jan. 1 Balance 135, Dec. 31 Balance 97,500 Share Investments 2014 Sept. 1 13,500 Oct. 1 24,000

50 (b) Dec. 31 Unrealized Gain or Loss Equity ( 97,500 93,400)... 4,100 Fair Value Adjustment Non-Trading... 4,100 Security Cost Fair Value Carlene Co. common Riverdale Co. common Raczynski Co. common 36,000 31,500 30,000 97,500 38,400 28,000 27,000 93,400 (1,200 32) (3,500 8) (1,500 18) (c) Investments Investments in shares of less than 20% owned companies, at fair value... 93,400 Equity Share capital ordinary... 1,500,000) Retained earnings... 1,000,000) Less: Unrealized loss on non-trading securities... 4,100 Total equity... 2,495,900