university of Karachi

Muhammad Ali
BS – III

Theory
Exercise: 11.4 - 11.6
Problems: 11.1 – 11.5

Submitted to: Mam kanza Nisar

FORMATION OF CORPORATION

A corporation is a business structure that allows owners to establish their company as a separate

legal entity. To form a corporation, an individual or group must adopt a corporate charter, or a

document used to incorporate a business, and file it with the state government. The charter

describes important aspects of the corporation, such as the name of the firm, the stock issued, and

the firm’s operations. The people who organize the corporation must also establish bylaws, which

are general guidelines for managing the firm. Since the shareholders of the corporation are legally

separated from the entity, they have limited liability, meaning that they are not held personally

responsible for the firm’s actions. The most that the stockholders of a corporation can lose is

the amount of money they invested. The stockholders of a corporation elect the members of the

board of di-rectors, who are responsible for establishing the general policies of the firm. One of

the board’s responsibilities is to elect the president and other key officers (such as vice-presidents),

who are then given the responsibility of running the business on a day-to-day basis. If the board

of directors becomes displeased with the performance of the key officers, the board has the power

to replace them. Similarly, if the stock holders become displeased with the performance of

members of the board, the stockholders can replace the directors in the next scheduled election. In

some corporations, one or a few individuals may serve as a stockholder, as a member of the board

of directors, and as a key officer of the firm. The chief executive officer of a business commonly

serves as the chair of the board.

STEPS TO START A CORPORATION

To form your own corporation, you must take these essential steps.

1. CHOOSING A CORPORATE NAME

The name of your corporation must comply with the rules of your state's corporation division. You

should contact your state's office for specific rules, but the following guidelines usually apply:

• The name cannot be the same as the name of another corporation on file with the

corporation’s office.

• The name must end with a corporate designator, such as "Corporation," "Incorporated,"

"Limited," or an abbreviation of one of these words (Corp., Inc., or Ltd.).

• The name cannot contain certain words that suggest an association with the federal

government or restricted type of business, such as Bank, Cooperative, Federal, National,

United States, or Reserve.

Your state's corporation’s office can tell you how to find out whether your proposed name is

available for your use. Besides following your state's corporate naming rules, you must make sure

your name won't violate another company's trademark. Once you've found a legal and available

name, you usually don't need to file the name of your business with your state. When you file your

articles of incorporation, your business name will be automatically registered.

2. APPOINTING DIRECTORS

Directors make major policy and financial decisions for the corporation. For example, the directors

authorize the issuance of stock, appoint the corporate officers and set their salaries, and approve

loans to and from the corporation. Directors are typically appointed by the initial owners

(shareholders) of the corporation before the business opens. Often, the owners simply appoint

themselves to be the directors, but directors do not have to be owners.

Most states permit a corporation to have just one director, regardless of the number of owners. In

other states, a corporation may have one director only if it has one owner; a corporation with two

owners must have at least two directors, and a corporation with three or more owners must have

three or more directors.

3. FILING ARTICLES OF INCORPORATION

After you've chosen a name for your business and appointed your directors, you must prepare and

file "articles of incorporation" with your state's corporate filing office. Typically, this is the

department or secretary of state's office, located in your state's capital city. While most states use

the term "articles of incorporation" to refer to the basic document creating the corporation, some

states use other terms, such as "certificate of incorporation" or "charter."

Articles of incorporation don't have to be lengthy or complex. In fact, you can usually prepare

articles of incorporation in just a few minutes by filling out a form provided by your state's

corporate filing office. Typically, the articles of incorporation must specify just a few basic details

about your corporation, such as its name, principal office address, and sometimes the names of its

directors.

4. CREATE CORPORATE BYLAWS

Not all states require corporations to draft corporate bylaws, but you should consider developing

them either way. Bylaws are some of the most important documents for a corporation because they

set forth the rights and duties of the shareholders, directors, and officers, as well as outline how

the corporation will operate.

Check with your local secretary of state’s office to see if corporate bylaws are required in the state

in which you plan to incorporate your business.

5. DRAFT A SHAREHOLDERS’ AGREEMENT

If desired, be sure to prepare and execute a shareholders’ agreement. A shareholders’ agreement

is often utilized by small, “closed” corporations that want to restrict who can become a new

shareholder and set provisions for how existing shareholders can exit the corporation and sell their

shares, among other requirements.

6. HOLDING A FIRST MEETING OF THE BOARD OF DIRECTORS

After the owners appoint directors, file articles of incorporation, and create bylaws, the directors

must hold an initial board meeting to handle a few corporate formalities and make some important

decisions. At this meeting, directors usually:

• set the corporation's fiscal or accounting year

• appoint corporate officers

• adopt the corporate bylaws

• authorize the issuance of shares of stock, and

• adopt an official stock certificate form and corporate seal.

Additionally, if the corporation will be an S corporation, the directors should approve the election

of S corporation status. (For information on whether your corporation should adopt S corporation

status).

7. ISSUING STOCK

You should not do business as a corporation until you have issued shares of stock. Issuing shares

formally divides up ownership interests in the business. It is also a requirement of doing business

as a corporation -- and you must act like a corporation at all times to qualify for the legal protections

offered by corporate status.

8. SECURITIES REGISTRATION

Issuing stock can be complicated; it must be accomplished in accordance with securities laws. This

means that large corporations must register their stock offerings with the federal Securities and

Exchange Commission (SEC) and the state securities agency. Registration takes time and typically

involves extra legal and accounting fees.

8. OBTAIN AN EMPLOYER IDENTIFICATION NUMBER

The Employer Identification Number (EIN) is basically the corporation’s Social Security number.

(Social Security numbers can only be issued to people, whereas the IRS issues EINs to businesses.)

This number is necessary to open a corporate bank account and file taxes. Some of the questions

on the EIN application have tax implications, so it might be a good idea to consult an attorney or

tax professional before registering. Owners can obtain an EIN by submitting an IRS Form SS-4.

9. OBTAIN REQUIRED LICENSES AND PERMITS

Your corporation should determine whether it needs any permits or licenses to operate. If so, you

must apply for both, likely with both a state and local agency.

STOCK DIVIDEND

A stock dividend is a method used by companies to distribute profit to shareholders. It is a dividend

payment made in the form of shares rather than cash. Stock dividends are primarily issued in lieu

of cash dividends when the company is low on liquid cash on hand. The board of directors decides

on when to declare a (stock) dividend and in what form the dividend will be paid.

CASH DIVIDEND

A cash dividend is a payment made by a company out of its earnings to investors in the form of

cash. This transfers economic value from the company to the shareholders instead of the company
using the money for operations. However, this does cause the company's share price to drop by

roughly the same amount as the dividend.

For example, if a company issues a cash dividend equal to 15% of the stock price, shareholders

will see a resulting loss of 15% in the price of their shares. This is a result of the economic value

transfer.

STOCK DIVIDEND

A stock dividend, on the other hand, is an increase in the number of shares of a company with the

new shares being given to shareholders. Companies may decide to distribute this type of dividend

to shareholders of record if the company's availability of liquid cash is in short supply.

For example, if a company were to issue a 5% stock dividend, it would increase the number of

shares by 5% (one share for every 20 owned). If there are one million shares in a company, this

would translate into an additional 50,000 shares. If you owned 100 shares in the company, you'd

receive five additional shares.

COMPANY ISSUE STOCK DIVIDEND INSTEAD OF CASH DIVIDEND

One of the best reasons for giving a stock dividend instead of a cash dividend may be that in giving

a stock dividend, a company and its shareholders forge psychologically stronger links, with the

investor owning more of the company with the additional shares.

Stock dividends are thought to be superior to cash dividends as long as they are not accompanied

by a cash option. Companies that pay stock dividends are giving their shareholders the choice of

keeping their profit or turning it to cash whenever they so desire; with a cash dividend, no other

option is given.
But this does not mean that cash dividends are bad, they just lack choice. However, a shareholder

could still reinvest the proceeds from the cash dividend back into the company through a dividend

reinvestment plan.

In many ways, it can be better for both the company and the shareholder to pay and receive a stock

dividend at the end of a profitable fiscal year. This type of dividend can be as good as cash, with

the added benefit that no taxes have to be paid when receiving the same.

EFFECTS OF DIVIDEND ON COMPANY PERFORMANCE

In many ways, it can be better for both the company and the shareholder to pay and receive a stock

dividend at the end of a profitable fiscal year. This type of dividend can be as good as cash, with

the added benefit that no taxes have to be paid when receiving the same.
PROBLEM 11.1

(a) SINCLAIR PRESS

STOCK HOLDERS’ EQUITY

8% preferred stock. $100 par value callable at $100, 100,000 shares

authorized and outstanding ………………………………………………………… $1,000,000

Common Stock, $1 stated value, authorized 500,000 shares, issued and outstanding

170,000 shares………………………………………………………………………… $170,000

Additional paid in Capital; common stock …………………………………………. $2,380,000

Total paid in capital…………………………………………………………………. $3,550,000

Retained Earnings……………………………………………………………………... $195,000

Total stock holder’s equity…………………………………………………………… $3745000

SINCLAIR PRESS
STATEMENT OF RETAINED EARNINGS
For the year Dec. 31, 2002

Net income for four-year period (1999 – 2002) …………………………….……… $1,025,000

Less: Dividends

Dividend on preferred stock (8 x 10,000) for four years…………………$320,000

Dividend on common stock (0.75 x 170,000) for four years.…….………$510,000

Total dividends………………………………………………………………………. ($830,000)

Retained Earnings for Dec.31 2002…………………………………………………...... $195,000

(b) There are no dividends in arrears at Dec 31. 2002. It can be said because common dividends

were paid in each of the four years that the company was exist. Common shareholder could not

receive dividends in each company working years that’s why had any dividend arrears on

preferred stock.

PROBLEM 11.2

(a) BANNER PUBLICATIONS

STOCK HOLDERS’ EQUITY

10% preferred stock. $100 par value callable at $100, 20,000 shares

authorized and outstanding ………………………………………………………… $2,000,000

Common Stock, $1 stated value, authorized 1 million shares, issued and outstanding

300,000 shares………………………………………………………………………… $300,000

Additional paid in Capital; common stock …………………………………………. $5,700,000

Total paid in capital…………………………………………………………………. $8,000,000

Retained Earnings……………………………………………………………………... $360,000

Total stock holder’s equity…………………………………………………...……… $8,360,000

 BANNER PUBLICATIONS
STATEMENT OF RETAINED EARNINGS
For the year Dec. 31, 2001

Net income for five-year period (1996 – 2000) …………………………….……… $4,460,000

Less: Dividends

Dividend on preferred stock (10 x 20,000) for five years…………………$1,000,000

Dividend on common stock (1 x 300,000) for five years.…….…………...$1,500,000

Total dividends…………………………………………………………………..…. ($2,500,000)

Retained Earnings for Dec.31 2000…………………………………………………... $1960,000

Less: Net loss of 2001…………………………………………………………….… ($1,600,000)

Retained Earning for Dec 31 2001……………………………………………...…….... $360,000

(b) As on Dec 31, 2001 dividends on the 10%, $100 par value. Cumulative preferred stock were

in arrears to the extend of $100 per share, amounting in total of (20,000*100) $2,000,000

(c) No dividends appear in arrears as a liability of co-operation until they are declared by the

board of directors.
PROBLEM 11.3
(a) MANHATTAN TRANSPORT COMPANY
STOCK HOLDERS’ EQUITY

8% preferred stock. $100 par value callable at $100, 5,000 shares

authorized and outstanding ……………………………………………………….… $5,00,000

9% preferred stock. no par value authorized 10,000 shares, issued and

outstanding 5,000 shares ………………………………………………………….....$5,12,000

Common Stock, $2 stated value, authorized 200,000 shares, issued and

outstanding 100,000 shares .………………………………………….…………… $200,000

Additional paid in Capital; common stock (100,000*6).………...…,………………. $600,000

Total paid in capital………………………………………………………………... $1,812.000

Retained Earnings……………………………………………………………………... $640,000

Total stock holder’s equity…………………………………………………...……… $2,452,000

 MANHATTAN TRANSPORT COMPANY
STATEMENT OF RETAINED EARNINGS
For the year Dec. 31, 2001

Retained Earning for Dec.31 1999…………………………………………………..... $170,000

Add: Net income for Dec.31 2000 and 2001………..……………………….……...… $890,000

Total Net Income for Dec.31 2001……………………………………….…………. $1,060,000

Less: Dividends

Dividend on preferred stock (8 x 5000 x 3) ….………………………….…$120,000

Dividend on preferred stock (9 x 5000 x 2) ….………………………...……$90,000

Dividend on common stock for 2000 (0.50 x 100,000)..…….…………........$50,000

Dividend on common stock for 2001 (1.60 x 100,000)..…….……………..$160,000

Total dividends………………………………………………………………….....…. ($420,000)

Retained Earnings for Dec.31 2001……………………………………………………. $640,000

(b) A corporation decide to use cumulative preferred stock rather than debt to finance operation

for any of the following reasons:

• Although cumulative dividends must eventually be paid if the corporation is profitable,

they do not have to paid each year and do not become legal obligation of the corporation

until they are declared. Interest on debt is a legal obligation of the corporation and must

be paid each year.

• Debt must be repaid at some future date. To be a permanent source of capital debt must

be periodically refinanced. Preffered stock generally does not mature.

• In creasing the amount of debt on a balance sheet can adversely affect financial

conditions.
PROBLEM 11.4

MOBILE COMMUNICATION INC.

GENERAL JOURNAL

DATE PARTICULARS DEBIT CREDIT

Cash (20,000 x 14) 280,000

Common stock (20,000 x 2) 40,000

Jan. 06
Add. Paid in cap. (20,000 x 12) 240,000

(To record issued 20,000 shares of $ 2 par value at $14

per share)
Preliminary Expenses 7,000

Common Stock (500 x 2) 1,000

Jan. 07
Add. Paid in cap. (20,000 x 12) 6,000

(To record issued 500 shares of $ 2 par value at $14 per

share)
Cash 250,000

Jan.12 Preferred Stock (2,500 x 100) 250,000

(To record issued 2,500 shares at par value)

Land (15,000 x 15) 225,000

Common stock (15,000 x 2) 30,000

Jun.04
Add. Paid in cap. (15,000 x 13) 195,000

(Issued 15000 shares of common stock at 2 par value

and 15 per share to acquire building etc.)
25,000
Dividends (preferred stock)
Nov.15 25,000
Dividends payable
(To record annual dividends on 5000 preferred shares
outstanding payable on Dec.20)
 25,000
Dividends payable
Dec.20 25,000
Cash
(To record payment of dividend was declared on Nov.
15)
106,500
Income Summary Account
Dec.31 106,500
Retained Earning

(To close income summary for the year)

25,000
Retained Earning
Dec.31 25,000
Dividend

(To close the dividends account)

MOBILE COMMUNICATION INC.

STOCK HOLDERS’ EQUITY

10% preferred stock. $100 par value callable at $100, 50,000 shares

authorized and outstanding (2,500 *100) ………………………………………….… $250,000

Common Stock, $2 stated value, authorized 400,000 shares, issued and

outstanding 35,500 shares …………………………………………………………..… $71,000

Additional paid in Capital; common stock ………………………………………....... $441,000

Total paid in capital…………………………………………………………………... $762,000

Retained Earnings……………………………………………………………………... $81,500

Total stock holder’s equity…………………………………………………...…….… $843,500

PROBLEM 11.5

a) (Total Par Value / Par Value) = 24,00,000 / 100 = 24,000

24,000 Shares have been issued

b) (Percent of Dividend * No. of Shares issued) = (7.5 * 24,000) = 180,000

Total number of dividends is $`180,000

c) (Total Par Value / Par Value) = 9,00,000 / 2 = 450,000

450,000 shares are outstanding

d). Par value of common stock …………………………………………...…….… $900,000

Additional Paid in capital ……...…………………………………...……… $83,25,000

Total Issued price of common stock ...…………………………...……….… $92,25,000

Number of total common stock…………………………………...………...… $450,000

Par value of common stock …...……………………………………...…….… $900,000

Average Issued price per share (9225000/450000)…………..…………………… $20.5

e). Total preferred stock + Total common stock = Total Legal Capital

24,00,000 + 9,00,000 = $33,00,000

f). Legal capital + Addition in paid in capital = Total paid in capital Capital

33,00,000 + 83,25,000 = $11,625,000

g). Total stock holder equity Par value of common stock ………..…….......… $14,940,000

less: Call price of preferred stock (24,000 * 105)……………….....……… $(25,20,000)

Equity of common stock holder ………………...………………………… $12,420,000

Common shares outstanding ……………………………………...………...… $450,000

Book value per share (12420000/450000)………………………...…………....… $27.6

EXERCISE 11.4

a). Calculation for first class (preferred stock 9%cumulative, $50 Par).

Dividend for first year: Dividend per share = 50 * 9% =4.5

Total amount of dividend per year = 4.5 * 2000,000 = $180,000

Total amount of dividend for 3 years $180,000 * 3 = $540,000

b) Calculation for second class (preferred stock, 12% non-cumulative, $100 par)

Dividend for the current: Dividend per share =100 * 12% = $12

Total amount of dividend =12 * 8000 = $96000

Calculation for third class (common stock, $5par, 400,000 shares issued)

Dividend for common stock: $736,000 – 636,000 = 100,000

Dividend per share = $100,000 = $0.25

d). Average price of preferred stock: -

Preferred stock, 9% cumulative

Par value of preferred share issued ………………………………………. 2000,000

Additional paid in capital …………………………………………………. 540,000

Total issued price ………………………………………………………… 2540,000

Number of preferred stock issued ………………………………………….. 40,000

Average issued price per share ………………………………………………. $63.5

(2540000/40000)

Preferred stock, 2% non-cumulative

Par value of preferred share issued ………………………………………... 800,000

Additional paid in capital …………………………………………………... 96,000

Total issued price ………………………………………………….……… 896,000

Number of preferred stock issued …………………………………………... 8,000

Average issued price per share ………………………………………………. $112

(896000/8000)

EXERCISE 11.5

a). Total par value = 15,000,000 = 150,000

Par value per share 100

150,000 shares of preferred stock have been issued.

b). 1,050,000 (150,000 * $7 per share)

c). Par value of common stock …………………………………………..... 20,000,000

Additional paid in capital …………………………………………….... 44,000,000

Total issued price ………………………………………………….…….64,000,000

Number of total common stock shares………………………………….... 4,000,000

Average issued price per share …………………………………………………. $16

(64,000,000/4,000,000)

d). Total legal capital = preferred stock + common stock

= 15,000,000 + 20,000,000

Total legal capital = 35,000,000

Total paid in-capital = legal capital + Additional paid in capital

= 35,000,000 + 44,300,000

Total paid in-capital= 35,000,000

e). Book value per share of common stock: -

Capital stock, 5% par value …………………………............................ 20,000,000

Additional paid in capital …………………………………………….... 44,000,000

Retained Earning ………………………………………………….…….64,450,000

Total stockholder equity ……………………………………................ 128,450,000

Book value per share = Total stock holder equity
Total outstanding share

Book value per share = 128,450,000 = $32.11

4,000,000

f). we can’t calculate the market price of share because it depends on the expectations of

investors.

EXERCISE 11.6

a). Land 450,000

Capital Stock (2 * 20,000) 40,000
Additional paid in capital 410,000

b). Land 450,000

Capital Stock (21.50 * 20,000) 430,000
Additional paid in capital 20,000