INTERNATIONAL ISLAMIC

UNIVERSITY ISLAMABAD (Women Campus)

INTRODUCTION TO BUSINESS FINANCE

ASSIGNMENT-2
Corporations
Submitted to:
MS SAMEEN AFTAB

Submitted by:
SUMAIRA YOUSUF

CORPORATIONS
A corporation is a legal entity having an existence separate from that of its owners.
It owns property on its own name, the assets belong t the corporation itself and not
to the owners. It has a legal status in court. As a legal entity, it may enter into
contracts and is responsible for its own debts and pays taxes on its earnings. A
corporation may have any number of investors. In dollar value of business activity,
corporations hold an impressive lead.

Shareholder: The owner of a corporation is called Stock or Share holder.

Publically owned Corporations:

A corporation whose shares are offered to sell in general public, is publically owned.

Closely Held Corporation:

A corporation restricts ownership to a limited group of investors.

Advantages of the Corporation

Creditors may only claim to the assets of the corporation; there is no personal
liability for the owners. Corporations have ease of accumulating capital; the sale of
corporate ownership attracts both small and large investors to invest. Readily
transferable shares of the stock have enabled corporations to a continuous life.
They are run by professional management.

Disadvantages of a Corporation
The combination of Federal and State Law has enabled the corporations to pay
taxes on its earnings and then shareholders pay taxes on their personal income,
which results in double taxation. State Law may provide considerable regulation for
the corporation activities. The management may operate corporation for the benefit
of insiders.

Income Taxes in corporate Financial Statements

Taxable Income doesn’t correspond precisely with any subtotal in Income
Statement. In most cases it is close to EBT (Earnings before Tax).

At the end of every accounting period, the estimated amount of corporate income
tax expense for the period is recorded in an adjusting entry.

Formation of a Corporation
A corporation is created by obtaining a charter from the state where the company
is to be incorporated.
To obtain the charter, an application called articles of incorporation is subscribed
to the state corporations’ commissioner or other designated official.

When the charter is obtained, Stock Holders elect the board of directors and B.O.Ds
then in turn select the corporate officers.

Organization Cost:

The cost that is made by the corporation for setting it up.

It includes:

1. The payment of incorporation fee to the state

2. The payment fee to attorneys
3. Payment to promoters

Rights of Stockholders
There are two types of Stockholders: Common Stock Holders and Preferred
Stockholders.

Stockholders have the right to vote for directors. Each share is entitled to one vote.
When the company takes out both preferred and common stock, only Common
stockholders have the right to vote.

The earning of the corporations are paid to the stockholders in the form of dividends
after getting declared by the B.O.Ds

In Case of Liquidation, the creditors are first paid in full, remaining are divided
among stockholders according to the share of ownership.

Functions of Board of Directors

The functions of B.O.Ds are to manage the corporation and protect the interest of
Stockholders. The formulate company’s policies, review acts of the corporate
officers declare dividends and set the salaries of officers.

Functions of Corporate officers

Corporate officers at the top level and selected by the B.O.Ds. They manage the
business on daily business.
Stockholders’ Equity

In the Balance Sheet, the term Stockholders’ equity is used instead of Owners’
Equity.

Both sources of Owners’ Equity are indicated:

1. Paid in Capital (Investment by the Stockholders)

2. Retained Earnings (Earnings from profitable operations of business)

When the investors buy the stock of the corporation, the following entry is
made:
Cash ………………………………………………….……………………. ********

Capital Stock ………………………………………………….……………………. ********

The increase in Stockholders equity arising from profitable operations is called

Retained Earning (the accumulates earnings the company since the date of
incorporation, minus any loses and minus all dividends). Retained Earnings is not an
asset; it is an element of equity.

At the end of year, the balance is closed in Retained earnings account:

Income Summary ………………………………………………….……………………. ********

Retained Earnings ………………………………………………….…………………….

********
(In case of profit. For Loss, it would be vice versa)

Stockholders’ Equity in the Balance Sheet

E.g. 1

Stockholders Equity:
Capital Stock ………………………………………………….……………………. $ 10,000

Retained Earnings ………………………………………………….……………. $5,000

$ 15,000
(In case of profit)

E.g. 2

Stockholders Equity:

Capital Stock ………………………………………………….……………………. $ 10,000

Less: Deficit ………………………………………………….……………………. $ 4,000

$ 6,000
(In case of Loss)

Deficit: It indicates negative amount of retained earnings.

Cash Dividends
Dividends are the distribution of cash to its stakeholders declared by the board of
directors. Once they are declared, it becomes a liability for the corporation to pay
them.

E.g. If dividend is declared $1 per share, the owner holding 100 shares would get
$100

Retained Earnings………………………………………………….…………………….
********

Dividend Payable………………………………………………….…………………….
********
(When the dividend is declared)

Dividend Payable………………………………………………….…………………….
********

Cash………………………………………………….…………………….
********
(When the dividend is paid)

Capital Stock:
The amount invested by the owners is called capital stock. The basic unit of a
capital is called a share
Authorized Shares:
Issuance of shares is approved by SEC (Security Exchange Commission). The
corporation may not issue all the shares that are authorized and issue them later on
when it needs capital.

Issue Shares:
These are the shares that are floated in the market by the corporation for selling.

Outstanding Shares:
The shares that are in the hands of stockholders.

Par Value/Stated Value:

It represents the legal capital per share. PAR Value maybe regarded as a minimum
cushion of equity capital existing for the protection of creditors.

State Law requires corporations to show separately the stockholders’ equity section
of the balance sheet the par value of shares issued.

Legal Capital: It is the amount equal to the par value per share.
Additional Paid-in-Capital: Amount that is invested by the owners of the
corporation in excess of the par value

Total Paid-in-Capital: Legal capital plus Additional paid-in-capital

E.g.

Stockholders’ Equity:

Capital Stock, $ 1 par value, authorized 40,000 shares, issued and

Outstanding 10,000 shares ……………………………………………………………………

……………………… $ 10,000

Additional Paid-in-Capital ……………………………………………………………………………

……………… 50,000

Total Paid-in-Capital ……………………………………………………………………

……………………… 60,000

Retained Earnings …………………………………………………………

………………………………… 80,000

Total Stockholders’ Equity ……………………………………………………………………

………………… 140,000
 COMMON STOCK PREFERRED SOCK

1. Primary Owners Secondary Owners

2. Voting Rights Don’t have the voting rights

3. Dividend is not fixed Get the specified amount of
dividends
4. Residual claim on assets at the time of At the event of
liquidation, get the assets after
5. Liquidation paying to the creditors and clearing
the taxes.
6. Not Callable Callable

Characteristics of Preferred Stock

1. Preferred Stockholders are preferred in paying dividends to common
stockholders.
2. If a company is not prospering and B.O.Ds don’t declare any dividend , next
time when the dividends are declared, cumulative dividend will be paid to
preferred stockholders before anything is paid to common stockholders.
3. In the event of liquidation, preferred stockholders are paid in full before
anything is paid to common stockholder. This amount also includes ‘dividend
in Arrears’
4. Preferred stocks can be called back by the corporation but with a slightly
higher price.
5. Corporation sometimes also offer ‘conversion privilege’ to preferred
stockholders.

Dividend in Arrears: It is the amount that is in arrears and would be

paid to the stockholders the next time dividends are declared. It is not a liability
because no liability exists until dividends are declared by the B.O.Ds. Its
disclosure is usually made by a note accompanying Balance Sheet.

Market Price of Preferred Stockholders

When the interest rate increases, market price of preferred stock decreases and
vice versa. Dividend rate is one important factor in determining the market price
of preferred share.

Market Price of Common Stockholders

Investors Expectations as to the profitability of future expectation greatly
affect the market value of Common Stock.

Changes in market price of the shares donor affect the Financial statements of a
corporation and changes are not recorded in the corporate accounting record.

The paid-in-capital in Balance Sheet represents the amount received when the
stock was issued, not the current market value of shares.

Underwriter: Investment banking firm, known as ‘underwriter’ is used as a

mean by the corporation to sell its stock. It guarantees the corporation a specific
price and makes profit by selling it to the public at slightly higher price.

Stock Certificate: When the investor buys stock of the corporation, he/she is
given a stock certificate indicating ownership of the investor.

Stock Registrar: A fiscal agent retained by the corporation to provide

assurance over issuance of stock certificates.

Stock transfer agent: A bank or trust company retained by the corporation

to maintain its records of capital stock ownership and to make transfers from one
investor to another.

Stockholders’ subsidiary Ledger: A record showing the number of

shares owned by each stockholder.

Denoted Capital: The asset the corporation receives as a gift

Stock issued for assets other than cash:
A corporation may issue shares of its capital stock in exchange of other assets.
When a corporations issues capital stock in exchange of assets other than cash, the
transaction should be recorded at the current market price.

Subscription to common stock:

Under subscription plan, investor agrees to purchase a specified amount of shares
at a future date.
E.g. A corporation issues 10,000 shares at $2 par value at stock price &15

Common stock subscribed Receivable: ……………………………………………………

150,000

Common stock subscribed ……………………………………………………

……. 20,000

Addition paid-in-Capital …………………………………………………

………. 130,000

Cash ……………………………………………………………………………………
60,000

Stock Subscription Receivable ………………………………………………………………………

…………… 60,000

(Collected subscriptions in full for 4,000 share at &15 each)

Capital Stock Subscribed ……………………………………………………………………………

……… 8,000

Common stock ………………………………………………………………………

…………… 8,000

(Issued certificates for 4,000 fully paid $2 par value shares)

Book Value:
Book value per share is equal to the net assets represented by one share of stock.
Net assets mean total assets minus total liabilities. In Book value, we are only
concerned with the number of share outstanding, not authorized.

To find book value of Common Stock: Total stockholders’ equity of

common stock

Number of Common Stock

If a company has both preferred and common stock, the call price per share of
preferred stock plus dividend in arrears are subtracted from stockholders’ equity
and then divided by the number of common stock.

Call Price: If the corporation decides to call back preferred stock, it is the price
paid per share.

Book Value and Market Price

Book Value is used in evaluating the reasonableness of market price of a stock. If a
stock is selling at a price well above book value, this is a sign showing that a
corporation is handled well, vice versa.