Stockholders' Equity: Classes of Capital Stock

Site: Saylor Academy
Course: BUS103: Introduction to Financial Accounting
Book: Stockholders' Equity: Classes of Capital Stock
Printed by: Guest user
Date: Friday, June 21, 2024, 8:17 PM

Description

Read this chapter, which details stockholders' equity, specifically capital stock. You learn about the different classes of stock, their characteristics, how capital appears on the Statement of Stockholders' Equity, and the steps for issuing stock to the public.

Learning objectives

After studying this chapter, you should be able to:

  • State the advantages and disadvantages of the corporate form of business.
  • List the values commonly associated with capital stock and give their definitions.
  • List the various kinds of stock and describe the differences between them.
  • Present in proper form the stockholders' equity section of a balance sheet.
  • Account for the issuances of stock for cash and other assets.
  • Determine book values of both preferred and common stock.
  • Analyze and use the financial results – return on average common stockholders' equity.

Source: Textbook Equity, https://learn.saylor.org/pluginfile.php/41461/mod_resource/content/20/AccountingPrinciples2.pdf
Creative Commons License This work is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License.

The accountant as a corporate treasurer

Most people think of the stock market as a place to buy and sell stock. However, few people give much thought to the other side of this transaction. The original purpose of the stock market is to allow corporations to raise the money needed to expand into new markets, invent new products, open new stores, and create new jobs. The initial public issuance of stock (i.e. going public) is one of the most significant milestones in the life of a public company.

For most individual investors, trading is done by stockbrokers. Who handles the stock transactions within a company? The treasurer or the person that performs the treasury functions is this person. This role requires someone with a strong background in accounting and finance.

When a company decides to issue bonds or additional shares of stock, the treasurer is the person responsible for executing the transaction at the lowest cost to the entity. The treasurer works closely with investment bankers and lawyers to get the stocks or bonds marketed and issued in accordance with state and federal laws. When a company issues stock for the first time (initial public offering, or IPO), the 175 task requires a thorough review of the financial position of the company and the public disclosure of this information for perhaps the first time. The treasurer/accountant must prepare what is called a prospectus. Among other things, the prospectus includes financial accounting information that is used in setting the price of the IPO.

The treasurer maintains custody of, or has access to, stocks owned by an entity and stock that is under the control of the entity. The treasurer also plays a pivotal role in the distribution of cash and stock dividends. The primary function of this position is controlling the cash inflows and outflows of the entity. A career as a corporate treasurer can involve the oversight of billions of dollars of stock, and the individual can earn a six-figure salary.

In this chapter, you study the corporate form of business organization in greater detail than in preceding chapters. Although corporations are fewer in number than single proprietorships and partnerships, corporations possess the bulk of our business capital and currently supply us with most of our goods and services.

This chapter discusses the advantages and disadvantages of the corporation, how to form and direct a corporation, and some of the unique situations encountered in accounting for and reporting on the different classes of capital stock. It is written from a US perspective, so you should be aware that laws and common practices may be different in other countries.

The corporation

A corporation is an entity recognized by law as possessing an existence separate and distinct from its owners; that is, it is a separate legal entity. Endowed with many of the rights and obligations possessed by a person, a corporation can enter into contracts in its own name; buy, sell, or hold property; borrow money; hire and fire employees; and sue and be sued.

Corporations have a remarkable ability to obtain the huge amounts of capital necessary for large-scale business operations. Corporations acquire their capital by issuing shares of stock; these are the units into which corporations divide their ownership. Investors buy shares of stock in a corporation for two basic reasons. First, investors expect the value of their shares to increase over time so that the stock may be sold in the future at a profit. Second, while investors hold stock, they expect the corporation to pay them dividends (usually in cash) in return for using their money. Chapter 13 discusses the various kinds of dividends and their accounting treatment.

Advantages of the corporate form of business

Corporations have many advantages over single proprietorships and partnerships. The major advantages a corporation has over a single proprietorship are the same advantages a partnership has over a single proprietorship. Although corporations have more owners than partnerships, both have a broader base for investment, risk, responsibilities, and talent than do single proprietorships. Since corporations are more comparable to partnerships than to single proprietorships, the following discussion of advantages contrasts the partnership with the corporation.

  • Easy transfer of ownership. In a partnership, a partner cannot transfer ownership in the business to another person if the other partners do not want the new person involved in the partnership. In a publicly held (owned by many stockholders) corporation, shares of stock are traded on a stock exchange between unknown parties; one owner usually cannot dictate to whom another owner can or cannot sell shares.
  • Limited liability. Each partner in a partnership is personally responsible for all the debts of the business. In a corporation, the stockholders are not personally responsible for its debts; the maximum amount a stockholder can lose is the amount of his or her investment. However, when a small, closely held corporation (owned by only a few stockholders) borrows money, banks and lending institutions often require an officer of the small corporation to sign the loan agreement. Then, the officer has to repay the loan if the corporation does not.
  • Continuous existence of the entity. In a partnership, many circumstances, such as the death of a partner, can terminate the business entity. These same circumstances have no effect on a corporation because it is a legal entity, separate and distinct from its owners.
  • Easy capital generation. The easy transfer of ownership and the limited liability of stockholders are attractive features to potential investors. Thus, it is relatively easy for a corporation to raise capital by issuing shares of stock to many investors. Corporations with thousands of stockholders are not uncommon.
  • Professional management. Generally, the partners in a partnership are also the managers of that business, regardless of whether they have the necessary expertise to manage a business. In a publicly held corporation, most of the owners (stockholders) do not participate in the day-to-day operations and management of the entity. They hire professionals to run the business on a daily basis.
  • Separation of owners and entity. Since the corporation is a separate legal entity, the owners do not have the power to bind the corporation to business contracts. This feature eliminates the potential problem of mutual agency that exists between partners in a partnership. In a corporation, one stockholder cannot jeopardize other stockholders through poor decision making.

The corporate form of business has the following disadvantages:

  • Double taxation. Because a corporation is a separate legal entity, its net income is subject to double taxation. The corporation pays a tax on its income, and stockholders pay a tax on corporate income received as dividends.
  • Government regulation. Because corporations are created by law, they are subject to greater regulation and control than single proprietorships and partnerships.
  • Entrenched, inefficient management. A corporation may be burdened with an inefficient management that remains in control by using corporate funds to solicit the needed stockholder votes to back its positions. Stockholders scattered across the country, who individually own only small portions of a corporation's stock, find it difficult to organize and oppose existing management.
  • Limited ability to raise creditor capital. The limited liability of stockholders makes a corporation an attractive means for accumulating stockholder capital. At the same time, this limited liability feature restrains the amount of creditor capital a corporation can amass because creditors cannot look to stockholders to pay the debts of a corporation. Thus, beyond a certain point, creditors do not lend some corporations money without the personal guarantee of a stockholder or officer of the corporation to repay the loan if the corporation does not.

Corporations are chartered by the state. Each state has a corporation act that permits the formation of corporations by qualified persons. Incorporators are persons seeking to bring a corporation into existence. Most state corporation laws require a minimum of three incorporators, each of whom must be of legal age, and a majority of whom must be citizens of the United States.

The laws of each state view a corporation organized in that state as a domestic corporation and a corporation organized in any other state as a foreign corporation. If a corporation intends to conduct business solely within one state, it normally seeks incorporation in that state because most state laws are not as severe for domestic corporations as for foreign corporations. Corporations conducting interstate business usually incorporate in the state that has laws most advantageous to the corporation being formed. Important considerations in choosing a state are the powers granted to the corporation, the taxes levied, the defenses permitted against hostile takeover attempts by others, and the reports required by the state.

Once incorporators agree on the state in which to incorporate, they apply for a corporate charter. A corporate charter is a contract between the state and the incorporators, and their successors, granting the corporation its legal existence. The application for the corporation's charter is called the articles of incorporation.

After supplying the information requested in the incorporation application form, incorporators file the articles with the proper office in the state of incorporation. Each state requires different information in the articles of incorporation, but most states ask for the following:

  • Name of corporation.
  • Location of principal offices.
  • Purposes of business.
  • Number of shares of stock authorized, class or classes of shares, and voting and dividend rights of each class of shares.
  • Value of assets paid in by the incorporators (the stockholders who organize the corporation).
  • Limitations on authority of the management and owners of the corporation. On approving the articles, the state office (frequently the secretary of state's office) grants the charter and creates the corporation.

As soon as the corporation obtains the charter, it is authorized to operate its business. The incorporators call the first meeting of the stockholders. Two of the purposes of this meeting are to elect a board of directors and to adopt the bylaws of the corporation.

The bylaws are a set of rules or regulations adopted by the board of directors of a corporation to govern the conduct of corporate affairs. The bylaws must be in agreement with the laws of the state and the policies and purposes in the corporate charter. The bylaws contain, along with other information, provisions for: (1) the place, date, and manner of calling the annual stockholders' meeting; (2) the number of directors and the method for electing them; (3) the duties and powers of the directors; and (4) the method for selecting officers of the corporation.

Organization costs are the costs of organizing a corporation, such as state incorporation fees and legal fees applicable to incorporation. The firm debits these costs to an account called Organization Costs. The Organization Costs account is an asset because the costs yield benefits over the life of the corporation; if the fees had not been paid, no corporate entity would exist. Since the account is classified on the balance sheet as an intangible asset, it is amortized over its finite useful life. Most organizations write off these costs fairly rapidly because they are small in amount.

As an illustration, assume that De-Leed Corporation pays state incorporation fees of USD 10,000 and attorney's fees of USD 5,000 for services rendered related to the acquisition of a charter with the state. The entry to record these costs is:

Organization Costs (+A) 15,000
Cash (-A) 15,000
To record costs incurred in organizing corporation.

Assuming the corporation amortizes the organization costs over a 10-year period, this entry records amortization at the end of the year:

Amortization Expense – Organization Costs (- SE) 1,500
Organization Costs (-A) 1,500
To record organization costs amortization expense.
(15,000/10 years = $1,500).


Management of the corporation is through the delegation of authority from the stockholders to the directors to the officers, as shown in the organization chart in Exhibit 19. The stockholders elect the board of directors. The board of directors formulates the broad policies of the company and selects the principal officers, who execute the policies.

Stockholders Stockholders do not have the right to participate actively in the management of the business unless they serve as directors and/or officers. However, stockholders do have certain basic rights, including the right to (1) dispose of their shares, (2) buy additional newly issued shares in a proportion equal to the percentage of shares they already own (called the preemptive right), (3) share in dividends when declared, (4) share in assets in case of liquidation, and (5) participate in management indirectly by voting at the stockholders' meeting.

The preemptive right allows stockholders to maintain their percentage of ownership in a corporation when additional shares are issued. For example, assume Joe Thornton owns 10 percent of the outstanding shares of Corporation X. When Corporation X decides to issue 1,000 additional shares of stock, Joe Thornton has the right to buy 100 (10 percent) of the new shares. Should he decide to do so, he maintains his 10 percent interest in the corporation. If he does not wish to exercise his preemptive right, the corporation may sell the shares to others.

Normally, companies hold stockholders' meetings annually. At the annual stockholders' meeting, stockholders indirectly share in management by voting on such issues as changing the charter, increasing the number of authorized shares of stock to be issued, approving pension plans, selecting the independent auditor, and other related matters.

At stockholders' meetings, each stockholder is entitled to one vote for each share of voting stock held. Stockholders who do not personally attend the stockholders' meeting may vote by proxy. A proxy is a legal document signed by a stockholder, giving a designated person the authority to vote the stockholder's shares at a stockholders' meeting.

Board of directors Elected by the stockholders, the board of directors is primarily responsible for formulating policies for the corporation. The board appoints administrative officers and delegates to them the execution of the policies established by the board. The board's more specific duties include: (1) authorizing contracts, (2) declaring dividends, (3) establishing executive salaries, and (4) granting authorization to borrow money. The decisions of the board are recorded in the minutes of its meetings. The minutes are an important source of information to an independent auditor, since they may serve as notice to record transactions (such as a dividend declaration) or to identify certain future transactions (such as a large loan).

Corporate officers A corporation's bylaws usually specify the titles and duties of the officers of a corporation. The number of officers and their exact titles vary from corporation to corporation, but most have a president, several vice presidents, a secretary, a treasurer, and a controller.

The president is the chief executive officer (CEO) of the corporation. He or she is empowered by the bylaws to hire all necessary employees except those appointed by the board of directors.

Most corporations have more than one vice president. Each vice president is responsible for one particular corporate operation, such as sales, engineering, or production. The corporate secretary maintains the official records of the company and records the proceedings of meetings of stockholders and directors. The treasurer is accountable for corporate funds and may supervise the accounting function within the company. A controller carries out the accounting function. The controller usually reports to the treasurer of the corporation.

Documents, books, and records relating to capital stock

Capital stock consists of transferable units of ownership in a corporation. Each unit of ownership is called a share of stock. Typically, traders sell between 100 and 400 million shares of corporate capital stock every business day on stock exchanges, such as the New York Stock Exchange and the American Stock Exchange, and on the over- the-counter market. These sales (or trades) seldom involve the corporation issuing the stock as a party to the exchange. Existing stockholders sell their shares to other individual or institutional investors. The physical transfer of the stock certificates follows these trades.

A stock certificate is a printed or engraved document serving as evidence that the holder owns a certain number of shares of capital stock. When selling shares of stock, the stockholder signs over the stock certificate to the new owner, who presents it to the issuing corporation. When the old certificate arrives, the issuing corporation cancels the certificate and attaches it to its corresponding stub in the stock certificate book. The issuer prepares a new certificate for the new owner. To determine the number of shares of stock outstanding at any time, the issuer sums the shares shown on the open stubs (stubs without certificates attached) in the stock certificate book.

Among the more important records maintained by a corporation is the stockholders' ledger. The stockholders' ledger contains a group of subsidiary accounts showing the number of shares of stock currently held by each stockholder. Since the ledger contains an account for each stockholder, in a large corporation this ledger may have more than a million individual accounts. Each stockholder's account shows the number of shares currently or previously owned, their certificate numbers, and the dates on which shares were acquired or sold. Entries are made in the number of shares rather than in dollars.

The stockholders' ledger and the stock certificate book contain the same information, but the stockholders' ledger summarizes it alphabetically by stockholder. Since a stockholder may own a dozen or more certificates, each representing a number of shares, this summary enables a corporation to (1) determine the number of shares a stockholder is entitled to vote at a stockholders' meeting and (2) prepare one dividend check per stockholder rather than one per stock certificate.

Many large corporations with actively traded shares turn the task of maintaining reliable stock records over to an outside stock-transfer agent and a stock registrar. The stock-transfer agent, usually a bank or trust company, transfers stock between buyers and sellers for a corporation. The stock-transfer agent cancels the certificates covering shares sold, issues new stock certificates, and makes appropriate entries in the stockholders' ledger. It sends new certificates to the stock registrar, typically another bank, that maintains separate records of the shares outstanding. This control system makes it difficult for a corporate employee to issue stock certificates fraudulently and steal the proceeds.

The minutes book, kept by the secretary of the corporation, is (1) a record book of the actions taken at stockholders' and board of directors' meetings and (2) the written authorization for many actions taken by corporate officers. Remember that all actions taken by the board of directors and the stockholders must be in accordance with the provisions in the corporate charter and the bylaws. The minutes book contains a variety of data, including:

  • A copy of the corporate charter.
  • A copy of the bylaws.
  • Dividends declared by the board of directors.
  • Authorization for the acquisition of major assets.
  • Authorization for borrowing.
  • Authorization for increases or decreases in capital stock.

Par value and no-par capital stock

Many times, companies issue par value stock. Par value is an arbitrary amount assigned to each share of a given class of stock and printed on the stock certificate. Par value per share is no indication of the amount for which the stock sells; it is simply the amount per share credited to the capital stock account for each share issued. Also, the total par value of all issued stock often constitutes the legal capital of the corporation. The concept of legal capital protects creditors from losses. Legal capital, or stated capital, is an amount prescribed by law (usually the par value or stated value of shares issued) below which a corporation may not reduce stockholders' equity through declaration of dividends or other payments to stockholders. Stated value relates to no-par stock and is explained below. Legal capital does not guarantee that a company can pay its debts, but it does keep a company from compensating owners to the detriment of creditors. The formula for determining legal capital is:

\text { Legal Capital }=\text { Shares Issued X Par(Stated) Value }

In 1912, the state of New York first enacted laws permitting the issuance of nopar stock (stock without par value). Many other states have passed similar, but not uniform, legislation.

A corporation might issue no-par stock for two reasons. One reason is to avoid confusion. The use of a par value may confuse some investors because the par value usually does not conform to the market value. Issuing a stock with no par value avoids this source of confusion.

A second reason is related to state laws regarding the original issue price per share. A discount on capital stock is the amount by which the shares' par value 185 exceeds their issue price. Thus, if stock with a par value of USD 100 is issued at USD 80, the discount is USD 20. Most states do not permit the original issuance of stock at a discount. Only Maryland, Georgia, and California allow its issuance. The original purchasers of the shares are contingently liable for the discount unless they have transferred (by contract) the discount liability to subsequent holders. If the contingent liability has been transferred, the present stockholders are contingently liable to creditors for the difference between par value and issue price. Although this contingent liability seldom becomes an actual liability, the issuance of no-par stock avoids such a possibility.

The board of directors of a corporation issuing no-par stock may assign a stated value to each share of capital stock. Stated value is an arbitrary amount assigned by the board to each share of a given class of no-par stock. The board may set this stated value, like par value, at any amount, although some state statutes specify a minimum amount, such as USD 5 per share. If not specified by applicable state law, the board may establish stated value either before or after the shares are issued.

Other values commonly associated with capital stock

Market value is the price of shares of capital stock bought and sold by investors in the market; it is the value of greatest interest to investors. Market price is directly affected by (1) all the factors that influence general economic conditions, (2) investors' expectations concerning the corporation, and (3) the corporation's earnings.

Book value per share is the amount per share that each stockholder would receive if the corporation were liquidated without incurring any further expenses and if assets were sold and liabilities liquidated at their recorded amounts. A later section discusses book value per share in greater detail.

Liquidation value is the amount a stockholder would receive if a corporation discontinued operations and liquidated by selling its assets, paying its liabilities, and distributing the remaining cash among the stockholders. Since the assets might be sold for more or less than the amounts at which they are recorded in the corporation's accounts, liquidation value may be more or less than book value. If only one class of capital stock is outstanding, each stockholder would receive, per share, the amount obtained by dividing the remaining cash by the number of outstanding shares. If two or more classes of stock are outstanding, liquidation value depends on the rights of the various classes.

A corporation issues certain capital stock with the stipulation that it has the right to redeem it. Redemption value is the price per share at which a corporation may call in (or redeem) its capital stock for retirement.

Capital stock authorized and outstanding

The corporate charter states the number of shares and the par value, if any, per share of each class of stock that the corporation is permitted to issue. Capital stock authorized is the number of shares of stock that a corporation is entitled to issue as designated in its charter.

A corporation might not issue all of its authorized stock immediately; it might hold some stock for future issuance when additional funds are needed. If all authorized stock has been issued and more funds are needed, the state of incorporation must consent to an increase in authorized shares.

The authorization to issue stock does not trigger a journal entry. Instead, companies note the authorization in the capital stock account in the ledger (and often in the general journal) as a reminder of the number of shares authorized. Capital stock issued is the number of shares of stock sold and issued to stockholders.

Capital stock outstanding is the number of authorized shares of stock issued and currently held by stockholders. The total ownership of a corporation rests with the holders of the capital stock outstanding. For example, when a corporation authorized to issue 10,000 shares of capital stock has issued only 8,000 shares, the holders of the 8,000 shares own 100 percent of the corporation.

Each outstanding share of stock of a given class carries rights and privileges identical to any other outstanding share of that class. Shares authorized but not yet issued are referred to as unissued shares (the previous example had 2,000 unissued shares). No rights or privileges are attached to these shares until they are issued; they are not entitled to dividends, nor can they be voted at stockholders' meetings.

The number of shares issued and the number of shares outstanding may be different. Issued stock has been issued at some time, while outstanding shares are currently held by stockholders. All outstanding stock is issued stock, but the reverse is not necessarily true. The difference is due to shares returned to the corporation by stockholders; it is called treasury stock. Chapter 13 discusses treasury stock.


An accounting perspective:

Business insight

SCI Systems, Inc., designs, manufactures, and distributes electronic products for a wide variety of industries. The following illustration is adapted from the company's balance sheet. The stockholders' equity section shows the actual number of shares of common stock authorized and outstanding and shows the dollar amounts in thousands:

June 30 2001 2000
Common stock, USD0.10 par value; authorized
500,000,000 common shares, issued 147,132,428 shares in 2001 and 144,996,374 shares in 2000.
USD 14,713 USD 14,500

Classes of capital stock

A corporation may issue two basic classes or types of capital stock – common and preferred.

If a corporation issues only one class of stock, this stock is common stock. All of the stockholders enjoy equal rights. Common stock is usually the residual equity in the corporation. This term means that all other claims against the corporation rank ahead of the claims of the common stockholder.

Preferred stock is a class of capital stock that carries certain features or rights not carried by common stock. Within the basic class of preferred stock, a company may have several specific classes of preferred stock, each with different dividend rates or other features.

Companies issue preferred stock to avoid: (1) using bonds with fixed interest charges that must be paid regardless of the amount of net income; (2) issuing so many additional shares of common stock that earnings per share are less in the current year than in prior years; and (3) diluting the common stockholders' control of the corporation, since preferred stockholders usually have no voting rights.

Unlike common stock, which has no set maximum or minimum dividend, the dividend return on preferred stock is usually stated at an amount per share or as a percentage of par value. Therefore, the firm fixes the dividend per share. Exhibit 20 shows the various classes and combinations of capital stock outstanding for a sample of 600 companies.

Common stock with: 2006 2005 2004 2003
No preferred stock 516 502 507 514
One class of preferred stock 73 81 80 71
Two classes of preferred stock 9 14 10 10
Three or more classes of preferred stock 2 3 3 5
Total Companies 600 600 600 600
Companies included above with two or more classes of common stock 62 70 59 66


Exhibit 20: Capital structures

Types of preferred stock

When a corporation issues both preferred and common stock, the preferred stock may be:

  • Preferred as to dividends. It may be noncumulative or cumulative.
  • Preferred as to assets in the event of liquidation.
  • Convertible or nonconvertible.
  • Callable.

A dividend is a distribution of assets (usually cash) that represents a withdrawal of earnings by the owners. Dividends are normally paid in cash.

Stock preferred as to dividends means that the preferred stockholders receive a specified dividend per share before common stockholders receive any dividends. A dividend on preferred stock is the amount paid to preferred stockholders as a return for the use of their money. For no-par preferred stock, the dividend is a specific dollar amount per share per year, such as USD 4.40. For par value preferred stock, the dividend is usually stated as a percentage of the par value, such as 8 percent of par value; occasionally, it is a specific dollar amount per share. Most preferred stock has a par value.

Usually, stockholders receive dividends on preferred stock quarterly. Such dividends – in full or in part – must be declared by the board of directors before paid. In some states, corporations can declare preferred stock dividends only if they have retained earnings (income that has been retained in the business) at least equal to the dividend declared.

Noncumulative preferred stock Noncumulative preferred stock is preferred stock on which the right to receive a dividend expires whenever the dividend is not declared. When noncumulative preferred stock is outstanding, a dividend omitted or not paid in any one year need not be paid in any future year. Because omitted dividends are lost forever, noncumulative preferred stocks are not attractive to investors and are rarely issued.

Cumulative preferred stock Cumulative preferred stock is preferred stock for which the right to receive a basic dividend, usually each quarter, accumulates if the dividend is not paid. Companies must pay unpaid cumulative preferred dividends before paying any dividends on the common stock. For example, assume a company has cumulative, USD 10 par value, 10 percent preferred stock outstanding of USD 100,000, common stock outstanding of USD 100,000, and retained earnings of USD 30,000. It has paid no dividends for two years. The company would pay the preferred stockholders dividends of USD 20,000 (USD 10,000 per year times two years) before paying any dividends to the common stockholders.

Dividends in arrears are cumulative unpaid dividends, including the quarterly dividends not declared for the current year. Dividends in arrears never appear as a liability of the corporation because they are not a legal liability until declared by the board of directors. However, since the amount of dividends in arrears may influence the decisions of users of a corporation's financial statements, firms disclose such dividends in a footnote. An appropriate footnote might read: "Dividends in the amount of USD 20,000, representing two years' dividends on the company's 10 percent, cumulative preferred stock, were in arrears as of 2007 December 31"

Most preferred stocks are preferred as to assets in the event of liquidation of the corporation. Stock preferred as to assets is preferred stock that receives special treatment in liquidation. Preferred stockholders receive the par value (or a larger stipulated liquidation value) per share before any assets are distributed to common stockholders. A corporation's cumulative preferred dividends in arrears at liquidation are payable even if there are not enough accumulated earnings to cover the dividends. Also, the cumulative dividend for the current year is payable. Stock may be preferred as to assets, dividends, or both.

Convertible preferred stock is preferred stock that is convertible into common stock of the issuing corporation. Many preferred stocks do not carry this special feature; they are nonconvertible. Holders of convertible preferred stock shares may exchange them, at their option, for a certain number of shares of common stock of the same corporation.

Investors find convertible preferred stock attractive for two reasons: First, there is a greater probability that the dividends on the preferred stock will be paid (as compared to dividends on common shares). Second, the conversion privilege may be the source of substantial price appreciation. To illustrate this latter feature, assume that Olsen Company issued 1,000 shares of 6 percent, USD 100 par value convertible preferred stock at USD 100 per share. The stock is convertible at any time into four shares of Olsen USD 10 par value common stock, which has a current market value of USD 20 per share. In the next several years, the company reported much higher net income and increased the dividend on the common stock from USD 1 to USD 2 per share. Assume that the common stock now sells at USD 40 per share. The preferred stockholders can: (1) convert each share of preferred stock into four shares of common stock and increase the annual dividend they receive from USD 6 to USD 8; (2) sell their preferred stock at a substantial gain, since it sells in the market at approximately USD 160 per share, the market value of the four shares of common stock into which it is convertible; or (3) continue to hold their preferred shares in the expectation of realizing an even larger gain at a later date.

If all 1,000 shares of USD 100 par value Olsen Company preferred stock are converted into 4,000 shares of USD 10 par value common stock, the entry is:

Preferred Stock (-SE) 100,000
Common Stock (+SE) 40,000
Paid-In Capital in Excess of Par Value – Common (+SE) 60,000
To record the conversion of preferred stock into common stock.


An accounting perspective:

Business insight

In the early 1970s, only about 10 percent of undergraduate degrees in accounting were awarded to women. This percentage increased steadily, and by the mid-1980s approximately half of all undergraduate accounting degrees were earned by women. By 1996, the rate increased to slightly more than half. This rate is more than twice the rate in the medical and legal professions. For more information see "Accounting's Big Gender Switch," Business Week, January 20, 1997, p. 20.


Most preferred stocks are callable at the option of the issuing corporation. Callable preferred stock means that the corporation can inform nonconvertible preferred stockholders that they must surrender their stock to the company. Also, convertible preferred stockholders must either surrender their stock or convert it to common shares.

Preferred shares are usually callable at par value plus a small premium of 3 or 4 percent of the par value of the stock. This call premium is the difference between the amount at which a corporation calls its preferred stock for redemption and the par value of the stock.

An issuing corporation may force conversion of convertible preferred stock by calling in the preferred stock for redemption. Stockholders who do not want to surrender their stock have to convert it to common shares. When preferred stockholders surrender their stock, the corporation pays these stockholders par value plus the call premium, any dividends in arrears from past years, and a prorated portion of the current period's dividend. If the market value of common shares into which the preferred stock could be converted is higher than the amount the stockholders would receive in redemption, they should convert their preferred shares to common shares. For instance, assume that a stockholder owns 1,000 shares of convertible preferred stock. Each share is callable at USD 104 per share, convertible to two common shares (currently selling at USD 62 per share), and entitled to USD 10 of unpaid dividends. If the issuing corporation calls in its preferred stock, it would give the stockholder either (1) USD 114,000 [(USD 104 + USD 10) X 1,000] if the shares are surrendered or (2) common shares worth USD 124,000 (USD 62 X 2,000) if the shares are converted. Obviously, the stockholder should convert these preferred shares to common shares.

Why would a corporation call in its preferred stock? Corporations call in preferred stock for many reasons: (1) the outstanding preferred stock may require a 12 percent annual dividend at a time when the company can secure capital to retire the stock by issuing a new 8 percent preferred stock; (2) the issuing company may have been sufficiently profitable to retire the preferred stock out of earnings; or (3) the company may wish to force conversion of its convertible preferred stock because the cash dividend on the equivalent common shares is less than the dividend on the preferred shares.

Balance sheet presentation of stock

The stockholders' equity section of a corporation's balance sheet contains two main elements: paid-in capital and retained earnings. Paid-in capital is the part of stockholders' equity that normally results from cash or other assets invested by owners. Paid-in capital also results from services performed for the corporation in exchange for capital stock and from certain other transactions discussed in Chapter 13. As stated earlier, retained earnings is the part of stockholders' equity resulting from accumulated net income, reduced by dividends and net losses. Net income increases the Retained Earnings account balance and net losses decrease it. In addition, dividends declared to stockholders decrease Retained Earnings. Since Retained Earnings is a stockholders' equity account and represents accumulated net income retained by the company, it normally has a credit balance. We discuss retained earnings in more detail in Chapter 13.

The following illustration shows the proper financial reporting for preferred and common stock. Assume that a corporation is authorized to issue 10,000 shares of USD 100 par value, 6 percent, cumulative, convertible preferred stock (five common for one preferred), all of which have been issued and are outstanding; and 200,000 shares of USD 10 par value common stock, of which 80,000 shares are issued and outstanding. The stockholders' equity section of the balance sheet (assuming USD 450,000 of retained earnings) is:

Stockholders' equity:
Paid-in capital:
Preferred stock – USD 100 par value, 6 percent cumulative, convertible (5 common for 1 preferred); authorized, issued, and outstanding, 10,000 shares $ 1,000,000
Common stock – USD 10 par value; authorized, 200,000 shares; issued and outstanding 80,000 shares 800,000
Total paid-in capital $ 1,800,000
Retained earnings 450,000
Total stockholders' equity 2,250,000


Notice that the balance sheet lists preferred stock before common stock because the preferred stock is preferred as to dividends, assets, or both. The company discloses the conversion rate in a parenthetical note within the description of preferred stock or in a footnote.


An accounting perspective:

Business insight

WHX corporation in its 1999 annual report provided the following presentation of preferred stock in the stockholders' equity second of its balance sheet:

1999
Stockholders' equity:
Preferred stock – $.10 par value: authorized 10,000 shares;
issued and outstanding: 5,883 shares
$588.3M

Stock issuances for cash

Each share of common or preferred capital stock either has a par value or lacks one. The corporation's charter determines the par value printed on the stock certificates issued. Par value may be any amount – 1 cent, 10 cents, 16 cents, USD 1, USD 5, or USD 100. Low par values of USD 10 or less are common in our economy.

As previously mentioned, par value gives no clue as to the stock's market value. Shares with a par value of USD 5 have traded (sold) in the market for more than USD 600, and many USD 100 par value preferred stocks have traded for considerably less than par. Par value is not even a reliable indicator of the price at which shares can be issued. New corporations can issue shares at prices well in excess of par value or for less than par value if state laws permit. Par value gives the accountant a constant amount at which to record capital stock issuances in the capital stock accounts. As stated earlier, the total par value of all issued shares is generally the legal capital of the corporation.

To illustrate the issuance of stock for cash, assume a company issues 10,000 authorized shares of USD 20 par value common stock at USD 22 per share. The following entry records the issuance:

Cash (+A) 220,000
Common Stock (+SE) 200,000
Paid-In Capital in Excess of Par Value – Common (+SE) 200,000
To record the issuance of 10,000 shares of stock for cash.


Notice that the credit to the Common Stock account is the par value (USD 20) times the number of shares issued. The accountant credits the excess over par value (USD 20,000) to Paid-In Capital in Excess of Par Value; it is part of the paid-in capital contributed by the stockholders. Thus, paid-in capital in excess of par (or stated) value represents capital contributed to a corporation in addition to that assigned to the shares issued and recorded in capital stock accounts. The paid-in capital section of the balance sheet appears as follows:

Paid-in capital:
Common stock – par value, $20; 10,000 shares authorized, issued and outstanding $ 200,000
Paid-in capital in excess of par value – common 20,000
Total paid-in capital $ 220,000


When it issues no-par stock with a stated value, a company carries the shares in the capital stock account at the stated value. Any amounts received in excess of the stated value per share represent a part of the paid-in capital of the corporation and the company credits them to Paid-In Capital in Excess of Stated Value. The legal capital of a corporation issuing no-par shares with a stated value is usually equal to the total stated value of the shares issued.

To illustrate, assume that the DeWitt Corporation, which is authorized to issue 10,000 shares of common stock without par value, assigns a stated value of USD 20 per share to its stock. DeWitt issues the 10,000 authorized shares for cash at USD 22 per share. The entry to record this transaction is:

Cash (+A) 220,000
Common Stock (+SE) 200,000
Paid-In Capital in Excess of Stated Value – Common (+SE) 20,000
To record issuance of 10,000 shares of stock for cash.


The paid-in capital section of the balance sheet appears as follows:

Paid-in capital:
Common stock – par value, $20; 10,000 shares authorized, issued and outstanding $ 200,000
Paid-in capital in excess of stated value  – common 20,000
Total paid-in capital $ 220,000


DeWitt carries the USD 20,000 received over and above the stated value of USD 200,000 permanently as paid-in capital because it is a part of the capital originally contributed by the stockholders. However, the legal capital of the DeWitt Corporation is USD 200,000.

A corporation that issues no-par stock without a stated value credits the entire amount received to the capital stock account. For instance, consider the DeWitt Corporation's issuance of no-par stock. If no stated value had been assigned, the entry would have been as follows:

Cash (+A) 220,000
Common Stock (+SE) 200,000
To record issuance of 10,000 shares for cash.


Since the company may issue shares at different times and at differing amounts, its credits to the capital stock account are not uniform amounts per share. This contrasts with issuing par value shares or shares with a stated value.

To continue our example, the paid-in capital section of the company's balance sheet would be as follows:

Paid-in capital:
Paid-in capital: Common stock – without par or stated value; 10,000 shares authorized, issued and outstanding $ 220,000
Total paid-in capital $ 220,000


The actual capital contributed by stockholders is USD 220,000. In some states, the entire amount received for shares without par or stated value is the amount of legal capital. The legal capital in this example would then be equal to USD 220,000.

Capital stock issued for property or services

When issuing capital stock for property or services, companies must determine the dollar amount of the exchange. Accountants generally record the transaction at the fair value of (1) the property or services received or (2) the stock issued, whichever is more clearly evident.

To illustrate, assume that the owners of a tract of land deeded it to a corporation in exchange for 1,000 shares of USD 12 par value common stock. The firm can only estimate the fair market value of the land. At the time of the exchange, the stock has an established total market value of USD 14,000. The required entry is:

Land (+A) 14,000
Common Stock (+SE) 12,000
Paid-In Capital in Excess of Par Value – Common (+SE) 2,000
To record the receipt of land for capital stock.


As another example, assume a firm issues 100 shares of common stock with a par value of USD 40 per share in exchange for legal services received in organizing as a corporation. No shares have been traded recently, so there is no established market value. The attorney previously agreed to a price of USD 5,000 for these legal services but decided to accept stock in lieu of cash. In this example, the correct entry is:

Organization Costs (+A) 5,000
Common Stock (+SE) 4,000
Paid-In Capital in Excess of Par Value – Common (+SE) 1,000
To record the receipt of legal services for capital stock.


The company should value the services at the price previously agreed on since that value is more clearly evident than the market value of the shares. It should debit an intangible asset account because these services benefit the corporation throughout its entire life. The company credits the amount by which the value of the services received exceeds the par value of the shares issued to a Paid-In Capital in Excess of Par Value – Common account.

Balance sheet presentation of paid-in capital in excess of par (or stated) value – Common or preferred

Accountants credit amounts received in excess of the par or stated value of shares to a Paid-In Capital in Excess of Par (or Stated) Value – Common (or Preferred) account. They carry the amounts received in excess of par or stated value in separate accounts for each class of stock issued. Using the following assumed data, the stockholders' equity section of the balance sheet of a company with both preferred and common stock outstanding would appear as follows:

Stockholders' equity:
Paid-in capital:
Preferred stock – $100 par value, 6% cumulative; 1,000 shares authorized, issued, and outstanding $100,000
Common stock – without par value, stated value, $5; 100,000 shares authorized, 80,000 shares; issued and outstanding 400,000 $ 500,000
Paid-in capital in excess of par (or stated) value:
From preferred stock issuances $ 5,000
From common stock issuances 20,000 25,000
Total paid-in capital $ 525,000
Retained earnings 200,000
Total stockholders' equity $ 725,000


The total book value of a corporation's outstanding shares is equal to its recorded net asset value – that is, assets minus liabilities. Quite simply, the amount of net assets is equal to stockholders' equity. When only common stock is outstanding, companies compute the book value per share by dividing total stockholders' equity by the number of common shares outstanding. In calculating book value, they assume that (1) the corporation could be liquidated without incurring any further expenses, (2) the assets could be sold at their recorded amounts, and (3) the liabilities could be satisfied at their recorded amounts. Assume the stockholders' equity of a corporation is as follows:

Stockholders' equity:
Paid-in capital:
Common stock – without par value, stated value, $10; authorized, 20,000 shares; issued and outstanding, 15,000 shares $ 150,000
Paid-in capital in excess of stated value 10,000
Total paid-in capital $ 160,000
Retained earnings 50,000
Total stockholders' equity $ 210,000
To determine the book value per share of the stock:
Total stockholders' equity $210,000
Total shares outstanding ÷15,000
Book value per share $ 14


When two or more classes of capital stock are outstanding, the computation of book value per share is more complex. The book value for each share of stock depends on the rights of the preferred stockholders. Preferred stockholders typically are entitled to a specified liquidation value per share, plus cumulative dividends in arrears, since most preferred stocks are preferred as to assets and are cumulative. In each case, the specific provisions in the preferred stock contract govern. To illustrate, assume the Celoron Corporation's stockholders' equity is as follows:

Stockholders' equity:
Paid-in capital:
Preferred stock – $100 par value, 6% cumulative; 5,000 shares authorized, issued, and outstanding $ 500,000
Common stock – $10 par value, 200,000 shares authorized, issued and outstanding 2,000,000
Paid-in capital in excess of par value – preferred 200,000
Total paid-in capital $2,700,000
Retained earnings 400,000
Total stockholders' equity $3,100,000


The preferred stock is 6 percent, cumulative. It is preferred as to dividends and as to assets in liquidation to the extent of the liquidation value of USD 100 per share, plus any cumulative dividends on the preferred stock. Dividends for four years (including the current year) are unpaid. You would calculate the book values of each class of stock as follows:

Total stockholders' equity Total Per Share
$3,100,000
Book value of preferred stock (5,000 shares)
Liquidation value (5,000 shares X $100) $ 500,000 620,000 $124.00*
Dividends (4 years at $30,000) 120,000 $2,480,000 12.40T
Book value of common stock (200,000 shares)
* $620,000 ÷ 5,000 shares.
T $2,480,000 ÷ 200,000 shares.


Notice that Celoron did not assign the paid-in capital in excess of par value – preferred to the preferred stock in determining the book values. Celoron assigned only the liquidation value and cumulative dividends on the preferred stock to the preferred stock.

Assume now that the features attached to the preferred stock are the same except that the preferred stockholders have the right to receive USD 103 per share in liquidation. The book values of each class of stock would be:

Total stockholders' equity Total Per Share
$3,100,000
Book value of preferred stock (5,000 shares) $ 515,000
Liquidation value (5,000 shares X $103) 120,000
Dividends (4 years at $30,000)
635,000 $ 127.00
Book value of common stock (200,000 shares) $2,465,000 12.33


Book value rarely equals market value of a stock because many of the assets have changed in value due to inflation. Thus, the market prices of the shares of many corporations traded regularly are different from their book values.

An accounting perspective:

Business insight

The Wall Street Journal publishes the New York Stock Exchange (NYSE) Composite Transactions each Monday through Friday except when the exchange is closed. For each stock listed on the NYSE, it lists the following data. We use data for the Kellogg Company, which produces ready-to-eat cereals and other food products, as recently reported in The Wall Street Journal as an example:

52 Weeks

Ytd percent chg Hi Lo Stock Sym Div Ytd percent PE Vol 100s Last Net Chg
+12.5 34 23.19 Kellog K 1.01 3.4 27 9957 29.54 +0.04


The first column reflects the stock price percentage change for the calendar year to date, adjusted for stock splits and dividends over 10 percent. The next two columns show the high and low price over the preceding 52 weeks plus the current week. The next two columns show the company name (Kellogg) and the NYSE's symbol (K) for that company. The Div column is the annual dividend based on the last quarterly, semiannual, or annual declaration. Yield percent is calculated as dividends paid divided by the current market price. The PE ratio is the closing market price divided by the total earnings per share for the most recent four quarters. The Vol 100s column shows the unofficial daily total of shares traded, quoted in hundreds. Thus, 995,700 shares of Kellogg's were traded that day. The next to last column shows the closing price for that day. The final column shows the change in the closing price as compared to the closing price of the preceding day.

Analyzing and using the financial results – Return on average common stockholders' equity

Stockholders' equity is particularly important to managers, creditors, and investors in determining the return on equity, which is the return on average common stockholders' equity.

The return on average common stockholders' equity measures what a given company earned for its common stockholders from all sources as a percentage of the common stockholders' investment. From the common stockholders' point of view, it is an important measure of the income-producing ability of the company. The ratio's formula is:

\text { Return on average common stockholders' equity }=\frac{\text { Net income available for common stockholders }}{\text { Average common stockholders'equity }}

If preferred stock is outstanding, the numerator is net income minus the annual dividend on preferred stock, and the denominator is the average total book value of common stock. If no preferred stock is outstanding, the numerator is net income, and the denominator is average stockholders' equity.

The Procter & Gamble Company reported the following information in its 2001 financial statements (USD millions):

2001
Net earnings $ 2,922
Stockholders' equity, beginning 12,287
Stockholders' equity, ending 12,010


The return on average common stockholders' equity for Procter & Gamble is 24.1 percent, or USD 2,922/[(USD 12,287 + USD 12,010)/2]. Investors view any increase from year to year as favorable and any decrease as unfavorable.

Since the stock market is frequently referred to as an economic indicator, the knowledge you now have on corporate stock issuances should help you relate to stocks traded in the market. Chapter 13 continues the discussion of paid-in capital and also discusses treasury stock, retained earnings, and dividends.


An ethical perspective:
Belex corporation

Joe Morrison is the controller for Belex Corporation. He is involved in a discussion with other members of management concerning how to get rid of some potentially harmful toxic waste materials that are a byproduct of the company's manufacturing process.

There are two alternative methods of disposing of the materials. The first alternative is to bury the waste in steel drums on a tract of land adjacent to the factory building. There is currently no legal prohibition against doing this. The cost of disposing of the materials in this way is estimated to be USD 50,000 per year. The best estimate is that the steel drums would not leak for at least 50 years, but probably would begin leaking after that time. The second alternative is to seal the materials in lead drums that would be disposed of at sea by a waste management company. The cost of this alternative is estimated to be USD 400,000 per year. The federal government has certified this method as the preferred method of disposal. The best estimate is that the lead drums would never rupture or leak.

Belex Corporation has seen some tough economic times. The company suffered losses until last year, when it showed a profit of USD 750,000 as a result of a new manufacturing project. So far, the waste materials from that project have been accumulating in two large vats on the company's land. However, these vats are almost full, so soon management must decide how to dispose of the materials.

One group of managers is arguing in favor of the first alternative because it is legally permissible and results in annual profits of about USD 700,000. They point out that using the second alternative would reduce profits to about USD 350,000 per year and cut managers' bonuses in half. They also claim that some of their competitors are now using the first alternative, and to use the second alternative would place the company at a serious competitive disadvantage.

Another group of managers argues that the second alternative is the only safe alternative to pursue. They claim that when the steel drums start leaking they will contaminate the ground water and could cause serious health problems. When this contamination occurs, the company will lose public support and may even have to pay for the cleanup. The cost of that cleanup could run into the millions.

Understanding the learning objectives

  • Advantages:

(a) Easy transfer of ownership.
(b) Limited liability.
(c) Continuous existence of the entity.
(d) Easy capital generation.
(e) Professional management.
(f) Separation of owners and entity.

  • Disadvantages:

(a) Double taxation.
(b) Government regulation.
(c) Entrenched, inefficient management.
(d) Limited ability to raise creditor capital.

  • Par value – an arbitrary amount assigned to each share of a given class of stock and printed on the stock certificate.
  • Stated value – an arbitrary amount assigned by the board of directors to each share of a given class of no-par stock.
  • Market value – the price at which shares of capital stock are bought and sold in the market.
  • Book value – the amount per share that each stockholder would receive if the corporation were liquidated without incurring any further expenses and if assets were sold and liabilities liquidated at their recorded amounts.
  • Liquidation value – the amount a stockholder would receive if a corporation discontinues operations, pays its liabilities, and distributes the remaining cash among the stockholders.
  • Redemption value – the price per share at which a corporation may call in (redeem) its capital stock for retirement.
  • Capital stock authorized – the number of shares of stock that a corporation is entitled to issue as designated in its charter.
  • Capital stock issued – the number of shares of stock that have been sold and issued to stockholders.
  • Capital stock outstanding – the number of authorized shares of stock that have been issued and that are still currently held by stockholders.
  • Two basic classes of capital stock:
  • (a) Common stock – represents the residual equity.
    (b) Preferred stock – may be preferred as to dividends and/or assets. Also may be cumulative and/or callable.

  • If the company has paid-in capital in excess of par value, the proper form would be:
Stockholders' equity:
Paid-in capital:
Preferred stock – $100 par value, 6% cumulative; 1,000 shares authorized, issued, and outstanding $ 100,000
Common stock – without par value, stated value, $5; 100,000 shares authorized,80,000 shares; issued and outstanding 400,000 $ 500,000
Paid-in capital in excess of par (or stated)value:
From preferred stock issuances $ 5,000
From common stock issuances 20,000 25,000
Total paid-in capital $ 525,000
Retained earnings 200,000
Total stockholders' equity $ 725,000


The following examples illustrate the issuance for cash of: (1) stock with a par value, (2) no-par value stock with a stated value, and (3) no-par value stock without a stated value.

  • Issuance of par value stock for cash – 10,000 shares of USD 20 par value common stock issued for USD 22 per share.
Cash (+A) 220,000
Common Stock (+SE) 200,000
Paid-In Capital in Excess of Par Value – Common (+SE) 20,000


  • Issuance of no-par, stated value stock for cash – 10,000 shares (no-par value) with USD 20 per share stated value issued for USD 22 per share.
Cash (+A) 220,000
Common Stock (+SE) 200,000
Paid-In Capital in Excess of Stated Value – Common (+SE) 20,000


  • Issuance of no-par stock without a stated value for cash – 10,000 shares (no-par value) issued at USD 22 per share.
Cash (+A) 220,000
Common Stock (+SE) 220,000


  • Example: A corporation has 200,000 shares of common stock and 5,000 shares of preferred stock outstanding. Preferred stock is 6 percent and cumulative. It is preferred as to dividends and as to assets in liquidation to the extent of the liquidation value of USD 100 per share, plus any cumulative dividends on the preferred stock. Dividends for three years are unpaid. Total stockholders' equity is USD 4,100,000. Calculations are as follows:
Total Per Share
Total stockholders' equity
$4,100,000
Book value of preferred stock (5,000 shares) $ 500,000
Liquidation value (5,000 shares X $100) 90,000 590,000 $ 118.00
Dividends (3 years at $30,000) $3,510,000 17.55
Book value of common stock (200,000 shares)


  • The return on average common stockholders' equity equals net income available to common stockholders divided by average common stockholders' equity.
  • The return on average common stockholders' equity is an important measure of the income-producing ability of the company.

Key Terms

Articles of incorporation The application for the corporation's charter.

Board of directors Elected by the stockholders to have primary responsibility for formulating policies for the corporation. The board also authorizes contracts, declares dividends, establishes executive salaries, and grants authorization to borrow money.

Book value per share Stockholders' equity per share; the amount per share each stockholder would receive if the corporation were liquidated without incurring any further expenses and if assets were sold and liabilities liquidated at their recorded amounts.

Bylaws A set of rules or regulations adopted by the board of directors of a corporation to govern the conduct of corporate affairs. The bylaws must be in agreement with the laws of the state and the policies and purposes in the corporate charter.

Callable preferred stock If the stock is nonconvertible, it must be surrendered to the company when the holder is requested to do so. If the stock is convertible, it may be either surrendered or converted into common shares when called.

Call premium (on preferred stock) The difference between the amount at which a corporation calls its preferred stock for redemption and the par value of the stock.

Capital stock Transferable units of ownership in a corporation.

Capital stock authorized The number of shares of stock that a corporation is entitled to issue as designated in its charter.

Capital stock issued The number of shares of stock that have been sold and issued to stockholders.

Capital stock outstanding The number of shares of authorized stock issued and currently held by stockholders.

Common stock Shares of stock representing the residual equity in the corporation. If only one class of stock is issued, it is known as common stock. All other claims rank ahead of common stockholders' claims.

Convertible preferred stock Preferred stock that is convertible into common stock of the issuing corporation.

Corporate charter The contract between the state and the incorporators of a corporation, and their successors, granting the corporation its legal existence.

Corporation An entity recognized by law as possessing an existence separate and distinct from its owners; that is, it is a separate legal entity. A corporation is granted many of the rights, and placed under many of the obligations, of a natural person. In any given state, all corporations organized under the laws of that state are domestic corporations; all others are foreign corporations.

Cumulative preferred stock Preferred stock for which the right to receive a basic dividend accumulates if any dividends have not been paid; unpaid cumulative preferred dividends must be paid before any dividends can be paid on the common stock.

Discount on capital stock The amount by which the par value of shares issued exceeds their issue price. The original issuance of shares at a discount is illegal in most states.

Dividend A distribution of assets (usually cash) that represents a withdrawal of earnings by the owners.

Dividend on preferred stock The amount paid to preferred stockholders as a return for the use of their money; usually a fixed or stated amount expressed in dollars per share or as a percentage of par value per share.

Dividends in arrears Cumulative unpaid dividends, including quarterly dividends not declared for the current year.

Domestic corporation See corporation.

Foreign corporation See corporation.

Incorporators Persons seeking to bring a corporation into existence.

Legal capital (stated capital) An amount prescribed by law (usually the par value or stated value of shares issued) below which a corporation may not reduce stockholders' equity through the declaration of dividends or other payments to stockholders.

Liquidation value The amount a stockholder will receive if a corporation discontinues operations and liquidates by selling its assets, paying its liabilities, and distributing the remaining cash among the stockholders.

Market value The price at which shares of capital stock are bought and sold in the market.

Minutes book The record book in which actions taken at stockholders' and board of directors' meetings are recorded; the written authorization for many actions taken by corporate officers.

Noncumulative preferred stock Preferred stock on which the right to receive a dividend expires if the dividend is not declared.

No-par stock Capital stock without par value, to which a stated value may or may not be assigned.

Organization costs Costs of organizing a corporation, such as incorporation fees and legal fees applicable to incorporation.

Paid-in capital Amount of stockholders' equity that normally results from the cash or other assets invested by owners; it may also result from services provided for shares of stock and certain other transactions.

Paid-in capital in excess of par (or stated) value – common or preferred Capital contributed to a corporation in addition to that assigned to the shares issued and recorded in capital stock accounts.

Par value An arbitrary amount assigned to each share of a given class of stock and printed on the stock certificate.

Preemptive right The right of stockholders to buy additional shares in a proportion equal to the percentage of shares already owned.

Preferred stock Capital stock that carries certain features or rights not carried by common stock. Preferred stock may be preferred as to dividends, as to assets, or as to both dividends and assets. Preferred stock may be callable and/or convertible and may be cumulative or noncumulative.

Proxy A legal document signed by a stockholder, giving another person the authority to vote the stockholder's shares at a stockholders' meeting.

Redemption value The price per share at which a corporation may call in (or redeem) its capital stock for retirement.

Retained earnings The part of stockholders' equity resulting from net income, reduced by dividends and net losses.

Return on average common stockholders' equity A measure of the income-producing ability of the company. It is the ratio of net income available to common stockholders divided by average common stockholders' equity.

Shares of stock Units of ownership in a corporation.

Stated value An arbitrary amount assigned by the board of directors to each share of a given class of no-par stock.

Stock certificate A printed or engraved document serving as evidence that the holder owns a certain number of shares of capital stock.

Stockholders' ledger Contains a group of subsidiary accounts showing the number of shares of stock currently held by each stockholder.

Stock preferred as to assets Means that in liquidation, the preferred stockholders are entitled to receive the par value (or a larger stipulated liquidation value) per share before any assets may be distributed to common stockholders.

Stock preferred as to dividends Means that the preferred stockholders are entitled to receive a specified dividend per share before any dividend on common stock is paid.

Stock registrar Typically, a bank that maintains records of the shares outstanding for a company.

Stock-transfer agent Typically, a bank or trust company employed by a corporation to transfer stock between buyers and sellers.

Stock without par value See no-par stock.

Unissued shares Capital stock authorized but not yet issued.