Introduction to Corporation Accounting

CORPORATION - an artificial being created by operation of law, having the right of succession and the powers, attributes and properties expressly authorized by law or incident to its existence (New Corporation Code of the Philippines). A corporation is an entity created by law that is separate and distinct from its owners and its continued existence is dependent upon the corporate statutes of the state in which it is incorporated. Characteristics of a Corporation The characteristics that distinguish a corporation from proprietorships and partnerships are: 1. Separate legal entity A corporation is an artificial being with a personality separate from that of its individual owners (i.e., the corporation has separate legal existence from its owners). 2. Created by operation of law A corporation is generally created by operation of law. The mere agreement of the parties cannot give rise to a corporation. 3. Right of succession A corporation continues to exist notwithstanding the withdrawal, death, insolvency or incapacity of the individual owners. Changes in the ownership structure do not dissolve a corporation this means that the corporation can have a continuous life. 4. Powers, attributes, properties expressly authorized by law Being a creation of law, a corporation can only exercise powers provided by law and powers which are incidental to its existence. 5. Ownership divided into shares Proprietorship in a corporation is divided into units known as shares of stocks. Ownership is shown in shares of share capital, which are transferable units. 6. Board of Directors (BOD) Management of the business is vested in a board of directors elected by the stockholders. The BOD is the governing body or decisionmaking body of the corporation. 7. The stockholders have limited liability. 8. It is relatively easy for a corporation to obtain capital through the issuance of stock. 9. The corporation is subject to numerous government regulations. 10. The corporation must pay an income tax on its earnings, and the stockholders are required to pay taxes on the dividends they receive: the result is double taxation.

Marivic Valenzuela-Manalo

Distinction between Partnerships and Corporations Partnership 1. Formed by at least two persons. 2. Starts with agreement among partners; may be formed orally. 3. Unlimited liability 4. Limited life 5. Transfer of equity of a partner needs the consent of all the partners. 6. Partner is an agent of the partnership. Classes of Corporation A. According to Purpose 1. 2. benefit. Public a corporation formed to render government service Private a corporation formed for a private purpose, aim or Corporation Initially formed by at least five persons. Starts with the issuance of a certificate of incorporation issued by SEC Limited liability Unlimited life Stocks can be transferred from one stockholder to another without getting the consent of the other stockholders. Stockholders do not act as agents of the corporation.

3. Quasi-public a private corporation which is given a franchise to perform functions of a public character. B. According to Law of Creation 1. Domestic a corporation that is organized under Philippine laws. 2. Foreign -- a corporation that is organized under the laws of other countries. C. According to Membership Holdings 1. Stock a corporation in which the capital is divided into shares of stock and is authorized to distribute dividends to the holders of such shares. A stock certificate is a physical evidence of the shares of stock. Stock corporations are generally profit-oriented. 2. Non-stock - a corporation in which capital comes from fees or contributions given by individuals. No part of its income is distributed as dividends and any profit shall be used to further the purpose(s) of the corporation. Non-stock corporations are generally non-profit in nature. D. According to the Extent of Membership 1. Open a corporation whose ownership is widely held by many investors.

Marivic Valenzuela-Manalo

2. Closely held or family a corporation in which 50% or more of its stock is owned by five persons or less. Components of a Corporation 1. Incorporators persons who originally formed the corporation and whose names appear in the Articles of Incorporation. They must be 5 but not more than 15 natural persons. They should not artificial persons. 2. owners of a stock corporation. 3. contributions to a non-stock corporation. Stockholders or shareholders Members persons who gave fees or

4. Corporators persons who compose the corporation whether as stockholders or members. 5. Promoters persons who undertake the necessary steps and procedures to organize the corporation. 6. Subscribers persons who agreed to buy shares of stock but will pay at a later date. 7. Underwriters persons who undertake to sell the shares of stocks to the general public. Advantages of a Corporate Form of Business 1. Unlimited life. The corporations power of succession enables it to enjoy a continuous existence. 2. The continuity of corporate existence enables it to obtain a strong credit line. 3. Bigger source of capital may be raised because many individuals invest funds in the corporation. 4. Stockholders enjoy limited liability. Liability of stockholders is limited to the extent of their investment in the corporation. 5. Ease of ownership transferability - shares of stocks may be transferred without the consent of the other stockholders. 6. The corporation has the capacity to act as a legal entity. 7. Centralized management under the Board of Directors. Disadvantages of a Corporate Form of Business 1. Difficulty in formation. It is not easy to form because of complicated legal requirements and high costs in its organization. 2. 3. The limited liability of the stockholders weakens or limits its credit capacity. It is subject to more governmental control.

Marivic Valenzuela-Manalo

4.

There is possibility of abuse of power by the Board of Directors because centralized management restricts active participation by stockholders in the conduct of corporate affairs. Corporations activities are limited by the articles of incorporation. It is subject to more taxes.

5. 6.

Legal Requirements in Organizing a Corporation The process of organizing a corporation consists of three stages: 1. Promotion makes preliminary arrangements and solicits subscription to raise sufficient capital for the business. The following are the preincorporation requirements: a. At least 25% of the authorized share capital as stated in the articles of incorporation must be subscribed. b. At least 25% of total subscriptions must be paid upon subscription. 2. Incorporation formalizes organization of the corporation by filing with SEC the necessary documentary requirements such as articles of incorporation and treasurers affidavit attesting compliance to the pre-incorporation requirements. Upon approval, SEC issues a certificate of incorporation, the date of which is considered as the date of registration or incorporation. 3. Commencement of the business the business should start its business within two years from the date of incorporation. Costs incurred in connection with the formation of the corporation are recorded as an expense. Examples of organization costs are filing fees, cost of printing stock certificates, promoters commission and legal fees. Any one of the following account titles may be used in recording organization costs: 1. Pre-operating Costs 2. Organization Expense 3. Organization Costs Articles of Incorporation The Articles of Incorporation enumerates the powers and limitations conferred upon the corporation by the government. It includes the following information: 1. 2. 3. 4. 5. 6. The name of the corporation; The purpose or purposes for which the corporation is formed; The place of the principal office of the corporation; The term of existence of the corporation, not exceeding 50 years; The names, nationalities and addresses of the incorporators; The names of the directors who will serve until their successors are duly elected and qualified in accordance with the by-laws;

Marivic Valenzuela-Manalo

7. The authorized share capital, the classes of stocks to be issued and the number of each class of stock indicating the par value if there is any; 8. The amount of subscription to the share capital, the names of the subscribers and the number of shares subscribed by each; 9. The total amount paid on the subscriptions and the amount paid by each subscriber on his subscription. By-Laws The by-laws of a corporation contain provisions for the internal administration of the corporation. The by-laws should be filed within one month from the date of issuance of the certificate of incorporation. The by-laws normally include the following: 1. The date, place and manner of calling the annual stockholders meeting; 2. The manner of conducting meetings; 3. The circumstances which may permit the calling of special meetings of the stockholders; 4. The manner of voting and the use of proxies; 5. The manner of electing the directors; 6. The term of office of the directors; 7. The authority and duties of the directors; 8. The manner of selecting the corporate officers; 9. The procedures for amending the articles of incorporation and by-laws. Corporate Books and Records The corporation generally maintains the following books of accounts and records: 1. Journals and Ledgers; 2. Minute books for meetings of stockholders; 3. Minute books for meetings of Board of Directors; 4. Stock and Transfer book - contains record of all stock, the names of stockholders or members alphabetically arranged; the installment paid and unpaid on all stocks, for which subscription has been made, any sale or transfer of stock. Classes of Stock 1. Par value a share of stock that is given a definite or fixed value in the articles of incorporation. 2. No par value a share of stock that has no fixed value; it may not be issued for less than P5.00.

Marivic Valenzuela-Manalo

3. Ordinary share the basic issue or ordinary/common type of shares. The ordinary share entitles the holder to the following basic rights: a. Right to vote in stockholders meeting; b. Right to share in corporate profits (dividends); c. Right to share in corporate profits upon liquidation; d. Right to purchase additional shares of stocks in the event that the corporation increases its share capital (pre-emptive right). 4. Preference share - entitles the holder to some specific preferences over the ordinary share such as a. Preference as to payment of dividends; b. Preference as to distribution of assets upon liquidation. Terms Commonly Used in Corporation Accounting 1. Authorized shares - refer to the maximum number of shares which may be issued by a corporation as set forth in the articles of incorporation. 2. Issued shares represent shares which were issued to stockholders in the past which at present may or may not be in the hands of stockholders. 3. Unissued shares shares which have never been issued and are available for issuance in the future. 4. Outstanding shares the total shares of stocks issued to subscribers or stockholders, whether or not fully or partially paid (as long as there is a binding subscription agreement) except treasury shares. 5. Treasury shares - shares which have been issued and fully paid for but subsequently reacquired by the issuing corporation by purchase or by donation.. 6. Subscribed shares shares which investors have contracted to acquire. 7. Subscription -is a contract between a subscriber (buyer of stock) and a corporation ( issuer of stock) whereby the former purchases shares of stocks of the latter with the payment to be made at the later date. 8. Certificate of stock - a written acknowledgment by the corporation of the stockholders interest in the corporation and its net assets. 9. Share Premium/Paid in capital in excess of par value/stated value - this account is credited for contribution in excess of par or stated value. 10. Pre-emptive right - the right of a stockholder to maintain his ownership interest in the corporation trough purchase of additional shares when new capital is issued. Marivic Valenzuela-Manalo 6

Unit 7
ACCOUNTING FOR CORPORATION FORMATION Accounting for Share Capital/Transactions Forming a Corporation The formation of a corporation involves (a) filing an application with the Securities and Exchange Commission (SEC), (b) paying an incorporation fee, (c) receiving a charter (articles of incorporation), and (d) developing by-laws. a. Costs incurred in forming a corporation are called organization costs. b. These costs include fees to underwriters, legal fees, state incorporation fees, and promotional expenditures. c. Organization costs are expensed as incurred. Ownership Rights of Stockholders When chartered, the corporation may begin selling ownership rights in the form of shares of stock. Each share of ordinary share gives the stockholder the following ownership rights: a. To vote for the board of directors and in corporate actions that require stockholder approval. b. To share in corporate earnings through the receipt of dividends. c. To maintain the same percentage ownership when additional shares of ordinary share are issued (preemptive right). d. To share in assets upon liquidation (residual claim). Stock Issue Considerations Authorized stock/share is the amount of stock/share a corporation is allowed to sell as indicated by its charter. a. The authorization of share capital does not result in a formal accounting entry. b. The difference between the shares of stock authorized and the shares issued is the number of unissued shares that can be issued without amending the charter. A corporation has the choice of issuing ordinary share directly to investors or indirectly through an investment-banking firm (brokerage house). Direct issue is typical in closely held companies, whereas indirect issue is customary for a publicly held corporation. Par value share/stock is share capital that has been assigned a value per share in the corporate charter. It represents the legal capital per share that must be retained in the business for the protection of corporate creditors. No-par share/stock is share capital that has not been assigned a value in the corporate charter. In many states the board of directors can assign a stated value to the shares, which becomes the legal capital per share. When there is no assigned stated value, the entire proceeds are considered to be legal capital.

Marivic Valenzuela-Manalo

The primary objectives in accounting for the issuance of ordinary share are to (a) identify the specific sources of paid-in capital and (b) maintain the distinction between paid-in capital and retained earnings. When par value ordinary share is issued for cash, the par value of the shares is credited to Ordinary share and the portion of the proceeds that is above or below par value is recorded in a separate paid-in capital account. When no-par ordinary share has a stated value, the stated value is credited to Ordinary share. When the selling price exceeds the stated value, the excess is credited to Paid-in Capital in Excess of Stated Value. When no-par stock does not have a stated value, the entire proceeds are credited to Ordinary share. Basic Share capital Transactions There are 5 basic share capital transactions: 1. Authorization records the maximum number of shares a corporation is authorized to issue. 2. Sale of stocks a stockholder buys stocks and pays immediately in full. Stock certificate is issued to the stockholder. 3. Subscription a subscriber enters into a contract to buy shares of stock. 4. Collection a subscriber pays his subscription either partially or in full. 5. Issuance of certificate if a subscription is fully paid; a stock certificate is issued to the subscriber. Share capital Share capital may be paid by the stockholder or subscriber in the form of 1. money/cash 2. property record the value of the property using the following amounts: a. fair value of the property received b. fair value of the shares of stock, whichever is clearly determinable; c. par value of the shares of stock 3. labor or services record the cost of the labor or services using the fair value of the services rendered. Important: When shares of stock are issued for services or non-cash assets, cost is either the fair market value of the consideration given up or the consideration received, whichever is more clearly determinable (Weygant, et al, 2006). Share capital may be issued 1. at par 2. at a premium at an amount more than the par value. The amount in excess of par value is treated as share premium.

Marivic Valenzuela-Manalo

Share capital cannot be issued at a discount or an amount less than par under the Philippine setting. When the value assigned to the asset received is greater than the par value times the number of shares issued, such issuance is called watered stock. The overstatement is done to comply with the requirement of the law that the stock should not be issued at less than its par value. When the value of the asset received is understated, the stock is said to contain secret reserves. Accounting Methods to Record Share capital Transactions 1. Memo entry method 2. Journal entry method Pro-forma Entries Par Value Stock Subscribed or Sold at Par Transaction Authorization Sale Subscription Collection Issuance of certificate Memo Entry Method Authorized to issue _____ shares with a par value of P___. Cash Share capital xxx xxx Journal Entry Method Unissued share capital xxx Authorized share capital xxx Cash Unissued share capital xxx xxx

Subscriptions receivable xxx Subscribed share capital xxx Cash xxx Subscriptions receivable xxx Subscribed share capital Share capital xxx xxx

Subscriptions receivable xxx Subscribed share capital xxx Cash xxx Subscriptions receivable xxx Subscribed share capital xxx Unissued share capital xxx

Pro-forma Entries Par Value Stock Subscribed or Sold at a Premium Transaction Authorization Sale Memo Entry Method Journal Entry Method Authorized to issue _____ shares with Unissued share capital xxx a par value of P___. Authorized share capital xxx Cash Share capital Share premium xxx xxx xxx Cash xxx Unissued share capital xxx Share premium xxx

Subscription

Subscriptions receivable xxx Subscriptions receivable xxx Subscribed share capital xxx Subscribed share capital xxx Share premium xxx Share premium xxx Cash xxx Subscriptions receivable xxx Subscribed share capital Share capital xxx xxx Cash xxx Subscriptions receivable xxx Subscribed share capital xxx Unissued share capital xxx

Collection Issuance of certificate

Marivic Valenzuela-Manalo

Special Notes: 1. The Subscription Receivable account title is always recorded at subscription prices computed as follows: Subscriptions receivable = subscribed shares x subscription price 2. Subscribed Share capital and Share capital accounts are always recorded/credited at par value. 3. Share Premium/Paid in Capital in Excess of Par is recorded/credited at amount in excess of par computed as follows: Paid in capital in excess of par = (Subscription price par value) (subscribed shares) Accounting for Two Classes of Stock The two classes of stock are ordinary share and preference share. Ordinary share entitles the holder to the four basic rights of a stockholder. Preference share is generally issued with par value and with a dividend rate. Voting right is frequently given exclusively to ordinary shareholders. The pro-form entries to record share capital transactions for two classes of stock are the same. However, the account titles must be labeled as to whether it is common or preferred. The following account titles may be used. Ordinary Subscriptions receivable ordinary Subscribed ordinary share Share premium- ordinary Ordinary share Preference Subscriptions receivable preference Subscribed preference share Share premium-preference Preference share

Accounting for No Par Shares No par shares do not have a definite or fixed value. 1. No par shares are recorded using the memo entry method only. 2. The entire consideration received by the corporation for its no par value shares shall be treated as capital and shall not be liable for distribution as dividends. 3. Preferred shares which are preferred as to assets can be issued only with par value. 4. Banks, trust companies, public utilities, buildings and loan associations, insurance companies cannot issue no-par stocks. 5. No par value shares may not be issued at an amount less than P5 per share. 6. While no par value shares do not carry a nominal value in the certificate, a selling price may be assigned. This value is called stated value. Stated value should not be less than P5 per share.

Marivic Valenzuela-Manalo

10

Pro-forma Entries: No Par Value Stock (Memo Entry Method) Transaction Authorization Sale No Stated Value With Stated Value Authorized to issue _____ shares, no Authorized to issue _____ shares, no par. par with a stated value of P___. Cash xxx Share capital , no par xxx Subscriptions receivable xxx Subscribed share capital xxx Cash xxx Share capital, no par xxx Share premium stated value xxx Subscriptions receivable xxx Subscribed share capital Share premiumPxx stated value xxx xxx

Subscription

Collection Issuance of certificate

Cash xxx Subscriptions receivable xxx Subscribed share capital Share capital , no par xxx xxx

Cash xxx Subscriptions receivable xxx Subscribed share capital xxx Share capital, no par xxx

Incorporating a Partnership
A partnership may incorporate after considering the many advantages of a corporate form of business. It is advisable that new set of books is used by the newly formed corporation. Steps or procedures in converting a partnership into corporate form of business Books of the Partnership 1. Finish the accounting cycle. 2. Revalue the assets and liabilities using the Capital Adjustment account. 3. Close the balance of the Capital Adjustment account to the partners capital accounts in accordance with their profit and loss ratio. Books of the Corporation 1. Record authorized capital sock. 2. Record the subscription of incorporators. 3. Record the transfer of the assets and liabilities of the partnership to the corporation. This serves as the payment of the subscription of the partners who became incorporators. Accounts receivable is transferred at gross amount together with the allowance for bad debts. Depreciable assets are transferred at net carrying amount. 4. Record the issuance of stocks to incorporators.

4. Close the accounts of the partnership except the capital accounts. 5. Record the receipt of stocks. 6. Record the distribution of stocks.

Marivic Valenzuela-Manalo

11

Marivic Valenzuela-Manalo

12

Pro-forma Entries: Books of the Partnership

a. Adjust the existing partnership books
Date P AR T IC UL AR S Increase in the asset value with no contra-asset account Asset Capital adjustment Decrease in the asset value with no contra-asset account Capital Adjustment Asset Increase in the asset value with contra-asset account Contra-asset Capital adjustment Decrease in the asset value with contra-asset account Capital adustment Contra-asset Close Capital adjustment account withdedit balance Rose, Cpital Guada, Capital Cpital adjustment P/R DEBIT X X X X X X X X CREDIT

X X X X X X X X

X X X X X X X X

X X X X X X X X

X X X X X X X X X X X X

Close Capital adjustment account with credit balance Capital adustment X X X X Rose, Capital Guada, Capital Note: These adjusting entries are similar to year-end adjustments. The only difference is that the Capital Adjustment account replaces all the nominal accounts which is eventually

X X X X X X X X

closed to the individual capital accounts of the partners.

Marivic Valenzuela-Manalo

13

b. Close all the ledger accounts with balances except the partners' capital account and debit "Receivable from Name of Corporation
Date P AR T IC UL AR S Receivable fron Name of Corporation Liabilities Allowance for bad debts Accumulated depreciation - PPE Assets To record the trasnfer of assets and liabilities to the newly formed corporation. P/R DEBIT X X X X X X X X X X X X X X X X X X X X CREDIT

c. Record the recipt of stocks from the newly formed corporation

Date P AR T IC UL AR S Stocks of Name of Corporation Receivable from Name of Corporation To record receipt of stock certificates P/R DEBIT X X X X CREDIT X X X X

d. Record the distribution of stocks to the partners.

Date P AR T IC UL AR S Rose, Capital Guada, Capital Stocks of Name of Corporation To record receipt of stock certificates P/R DEBIT X X X X X X X CREDIT

X X X X

Note: The debits to the partners capital accounts represent their final capital balances

Pro-forma Entries: Books of the New Corporation Authorization Subscription Collection/Transfer of partnership assets and liabilities Authorized to issue _____ shares with a par value of P ___. Subscriptions receivable Subscribed share capital Assets Liabilities Allowance for bad debts Subscriptions receivable Issuance of stock certificates Subscribed share capital Share capital xxx xxx xxx xxx xxx xxx xxx xxx

Marivic Valenzuela-Manalo

14

Accounting for Delinquent Subscription

There are instances when a subscriber cannot pay in full the amount he subscribed to. Payment of the balance on subscription may either be specified in the contract of subscription or in lieu thereof may be subject to call by the Board of Directors. According to the Corporation Code of the Philippines, if within thirty (30) days from the said date, no payment is made; all stocks covered by said subscription shall thereupon become delinquent and shall be subject to sale. When a subscriber fails to pay his subscription on the call date, the corporation sends several notices to remind him of his obligation. If no payment was made by the subscriber, his subscription is declared as delinquent subscriptions and the subscriber is called a defaulting subscriber. And these delinquent stocks are offered for sale in a public auction. 1. The sale of the delinquent stocks is advertised to have possible buyers/bidders. All expenses incurred relating to the sale of the delinquent shares will be charged or debited to Receivable from Highest Bidder account since this amount will eventually be collected to the highest bidder together with the unpaid balance of the subscription. 2. An auction sale is conducted where a highest bidder is chosen. 3. The sale of the delinquent subscription is issued to the highest bidder. 4. The highest bidder is the one who is willing to pay the unpaid balance of the subscription plus accrued interest plus all expenses related to the sale and who is willing to receive the least/smallest number of shares. 5. Once the subscription is fully paid, all subscribed shares are issued. Shares are first given to the highest bidder. The excess shares are given to the defaulting subscriber. 6. If there is no bidder, all of the delinquent shares will be issued in the name of the corporation. Such shares are considered treasury shares. The defaulting subscriber does not get any share of stock.

Marivic Valenzuela-Manalo

15

Pro-forma Entries using the Short Method of accounting for delinquent stocks
a. Record the subscription Date P A RTIC U L A RS Subscription receivable Suscribed share capital b. Record partial collection Cash Subscription receivable X X X X X X X X P/R DEBIT X X X X X X X X CREDIT

c. Corporation sends several notices but no payment was made by the subscriber No entry d. The corporation incurred costs related to the selling of the delinquent shares Receivable from highest bidder X X X X Cash X X X X e. The highest bidder pays and corresponding stock certificates are issued Cash X X X X Subscribed share capital X X X X Receivable fro highest bidder X X X X Subscriptions receivable X X X X Share capital X X X X OR f. If there is no bidder at all Treasury stock X X X X Subscribed share capital X X X X Receivable fro highest bidder Subscriptions receivable Share capital

X X X X X X X X X X X X

Illustrative problem: Assume that Joseph subscribed 250 shares of Ordinary share at P25.00 (P20.00 is the par value). After paying 50% on his subscriptions, he defaulted. Due process was taken and the shares were declared delinquent. Advertising and other cost including those advances made by the corporation amounted to P500.00 At the public auction, bids from Mary, Clare and Luisa were received. Mary bid 230 shares; Clare for 240; and Luisa for 245 shares. The highest bidder paid the amount due and stock certificate was issued by the corporation. REQUIRED: Record the above transactions.

Marivic Valenzuela-Manalo

16