Chapter V: Part II: Classes of Accounts (3)

CREATION OF CORPORATIONS

=5.= A corporation is created by legislative act. Formerly each corporation received a special charter from the legislature of the state, but as the advantages of corporations began to receive universal recognition it was seen that the delays incident to the granting of special charters were bound to work a hardship on those desiring to incorporate. Partly to overcome this, but more particularly to insure uniformity in the rights and privileges of corporations, and to prevent the conferring of special privileges through special charters, the legislature of most states has enacted uniform corporation laws. These statutes prescribe uniform regulations for the organization of corporations. State constitutions now very generally prohibit the granting of special charters to private corporations.

=6. Requirements.= While every state has its own corporation laws, the requirements of corporations are in many respects uniform. The law usually provides that a certificate of incorporation shall be filed with the secretary of state, or some other designated officer. This certificate must as a rule state:

The name of the corporation;

The place of business, where its principal office is located;

The objects of the corporation, including a statement of the business in which it is to engage;

The amount of the capital stock, and the number and par value of the shares into which it is to be divided;

The period for which the corporation is organized;

The number of its directors and the names of those who are to serve at the outset;

The names and addresses of the original incorporators with the number of shares of the capital stock subscribed for by each.

The form of the certificate required in the state of Illinois is shown in the illustration, p. 4.

STOCKHOLDERS

=7.= The members of a business corporation are known as stockholders or shareholders. At the time of organization the members subscribe for the shares of the capital stock agreeing to take and pay for them when issued. When the stock has been delivered and paid for, the stockholder is under no further obligation, unless the stock is by statute or contract subject to assessment.

=8. Stock Certificate.= When a stockholder has paid for his shares a certificate, known as a stock certificate, is issued to him. This certificate is the written evidence issued by the corporation that the person whose name appears therein is registered on the company's books as the owner of shares of the number and par value named.

The owner of a stock certificate can transfer it, and the one to whom it is transferred becomes a stockholder. Such transfers are not complete, however, until registered on the books of the company. A stock certificate is not, strictly speaking, a negotiable instrument, but it is the custom among business men to indorse stock certificates in blank and transfer them from hand to hand as negotiable instruments, until some one inserts his own name and has the transfer registered on the books of the company.

Such indorsement does not make a stock certificate a negotiable instrument, and the purchaser can acquire no better title than is possessed by the seller. Courts have held that the fact that a certificate of stock is not payable to bearer makes it non-negotiable.

CAPITALIZATION

=9.= This is the term commonly used to designate the amount of stock which the company is authorized to issue. It may have little reference to the amount subscribed or paid in, for most states authorize corporations to begin business as soon as a certain number of shares have been subscribed for, or even when only a small part of the subscriptions have been paid. For instance, a company with an authorized capitalization of $100,000 may be permitted to commence business as soon as $10,000 has been subscribed and $1,000 is actually paid in.

=10. Capital and Capital Stock.= The _capital_ of a corporation is usually understood to mean its assets, and is a general term covering all of its property of every nature. It has no connection with the capital stock authorized or the number of shares subscribed.

_Capital Stock_ is a term used in many ways each of which implies a different meaning. It may mean the amount which must be paid in before it can transact business as a corporation; it may mean the capital which the corporation is authorized to issue; it may mean the amount subscribed regardless of the amount actually paid in; or it may mean the amount actually paid in regardless of the amount subscribed.

=11. Kinds of Stock.= As a rule the capital stock of a corporation is of two classes--common and preferred--though not all corporations issue both classes.

_Common Stock_ is the stock of a corporation issued to all stockholders under the same conditions, and which is to share equally in the dividends.

_Preferred Stock_ is stock which gives its owner certain preferences over the owners of common stock. This preference usually consists of a provision for the payment of certain dividends out of the net earnings of the business before any dividends can be paid on common stock. The officers of a corporation have no power to issue preferred stock unless it is provided for in the charter. Preferred stock may, however, be issued with the consent of all common stockholders. Preferred stock falls into subdivisions depending upon its provisions as follows:

_Cumulative_ preferred stock is stock on which the payment of dividends is not dependent upon the earnings of one year. If a dividend is passed in one year or if not paid in full, it must be paid from future earnings before common stock can draw dividends.

_Non-cumulative_ preferred stock is stock which carries a dividend preference only in respect to the earnings of the current year. While dividends are payable prior to dividends on common stock, no liability attaches to the corporation if earnings in any year are insufficient to pay dividends.

_Guaranteed Stock_ is another name for cumulative or non-cumulative preferred stock--any stock on which the payment of dividends is guaranteed.

A corporation may issue more than one series of preferred stock, as _first preferred_, _second preferred_, etc. These issues take preference in the payment of dividends in the order of their priority. Dividends must be paid on _first preferred_ before any surplus is available for the payment of dividends on _second preferred_.

=12. Treasury Stock.= This is stock subscribed for and issued which has been acquired by the corporation either by purchase or donation. The term is often erroneously applied to that part of the authorized capital stock which has never been issued, and the error has even been made of referring to it as unsubscribed stock. Treasury stock is an asset and should be so treated on the books of the corporation. Unsubscribed or unissued stock is in no sense an asset; or as one writer puts it, no more an asset than the power of a person to issue notes is an asset.

=13. Watered Stock.= Any stock which is not represented by actual assets is called watered stock. It is usually represented by fictitious assets--as patents, copyrights, franchises, promotion expense, goodwill, etc.

STOCK SUBSCRIPTIONS

=14.= It is customary for the first board of directors to state by resolution in what manner the stock is to be disposed of; if subscriptions are to be received; if subscriptions are to be paid immediately or in installments. When the certificate of incorporation has been filed the subscription list is opened. This may be in book form, or a written or printed list. The following is a common form of stock subscription:--

We, the undersigned, do hereby subscribe to the capital stock of the --------company, organized under the laws of the state of --------in the amount set forth below, and severally agree to pay the amount of such subscription as follows:

When the board of directors shall, through its secretary or treasurer, certify that there has been subscribed----% of the authorized capital of $--------, then we severally agree to pay----% of said subscriptions, and to pay a further----% on the----day of each month thereafter, until the full amount of such subscriptions shall have been paid.

MANAGEMENT OF CORPORATIONS

=15.= The affairs of a corporation are managed by its directors who are elected by the stockholders. A director has no authority individually to bind the company. He can only act in conjunction with other directors in regular meeting as provided by the by-laws. The acts of the board are effected by orders or resolutions passed at such meetings. The number of directors constituting the board and the number required to form a quorum is specified in the by-laws. Directors must attend meetings in person to be entitled to vote. They cannot be represented by proxy. Since it is not practicable for the directors to attend to all of the details, they usually delegate to their officers authority to transact all of the every day business of the company. In larger corporations the directors organize themselves into subcommittees as executive committee, finance committee, etc. In small corporations these committees are unnecessary, their acts being performed by the board of directors.

=16. Powers of Directors and Officers.= The powers of the directors are extensive and are prescribed by the charter and by-laws. The directors have the power to bind the corporation in all its dealings with other persons or corporations. The powers of the stockholders are limited to the election of the directors; but as the directors are elected by a majority of the stockholders, the power to control the corporation through the election of a board of directors who will respect their wishes is thus conveyed to a majority of the stockholders.

Being representatives of the stockholders as a body, the directors must at all times be governed by what they honestly consider the wishes of the majority. Directors have the power to make contracts with the corporation only when they are manifestly fair contracts. For example, when not otherwise provided for, they may fix a fair compensation for their services and for the services of their officers. Except in cases of actual fraud, it is for the majority of stockholders to complain of such contracts, and they have the power to remove offending directors.

Officers of a corporation are its agents and have limited powers, usually prescribed by the by-laws. When not so specified, they are prescribed by the directors. It is not always necessary that all of the powers of an officer be specified in detail. If an officer has been accustomed to perform certain acts with the knowledge and consent of the directors, his acts become binding on the corporation. The title of an office does not necessarily convey any special powers. For example, while it is customary for the directors to confer special powers on the president, his title does not make him, in the corporation's dealings with the public, an agent of higher grade than the secretary, treasurer, or any other officer.

=17. Powers of Corporations.= As such, a corporation possesses certain necessary powers, and such other special powers as may be conferred by its charter.

To have a corporate name which can only be changed by law.

To sue and be sued.

To possess a corporate seal.

To appoint the necessary officers for the conduct of its business.

To enact by-laws necessary for the management of its business, for transferring of its stock, for calling of meetings, etc.

To acquire and dispose of such property as may be necessary for the conduct of the business for which it is organized.

To make contracts necessary for the carrying out of its purposes.

In general a corporation can engage in no other business than that specified in its charter, but it is granted certain incidental powers necessary to carry out its original purpose.

=18. Stockholder's Rights.= Each stockholder has the right to have a certificate of stock issued to him; to vote at meetings of stockholders; to inspect the books of the company; to participate in dividends; to invoke the aid of the courts in restraining the directors from committing a breach of trust.

DIVIDENDS

=19.= Every business corporation is conducted with a view to earning profits. When such profits are distributed to its stockholders they are called dividends, but stockholders cannot participate in the profits until a dividend has been declared by the directors. The law specifies that dividends must be paid out of the net surplus of the company, and provides a penalty for their payment out of capital. Therefore, before declaring a dividend, the directors must be provided with a balance sheet and use every care to determine that a surplus actually exists. For dividend purposes, surplus is usually considered that part of the profits remaining after paying expenses and providing the necessary reserve to cover depreciation of machinery and buildings and losses from uncollectable accounts. Sometimes a further provision is made in the by-laws for the creation of a sinking fund for the payment of bonds.

The times for the payment of dividends are fixed in the certificate of incorporation or the by-laws. Provision is usually made for the payment of dividends either quarterly, semi-annually, or annually.

Directors have full discretion in the declaration of dividends and, so long as they are acting in good faith, may add profits to capital instead of declaring a dividend. When the directors have, by proper resolution, stated that the surplus, or a part of the surplus, shall be distributed to the stockholders, a dividend is said to have been declared. When declared, a dividend becomes a debt of the corporation to its stockholders. It is not necessary that the directors declare dividends of all the surplus or net profits. Frequently the by-laws provide that a certain amount be reserved as working capital, and under any circumstances the questions of the advisability of declaring a dividend rests with the directors. They cannot be compelled to declare a dividend unless it can be shown that, in declining to do so, they are acting in bad faith.

=20. Stock Dividends.= At their discretion, the directors may, instead of paying a dividend in cash, declare what is known as a stock dividend. When there remains certain unsubscribed stock, or when the corporation is in possession of treasury stock, this stock may be issued to stockholders in payment of dividends. A stock dividend cannot, however, be declared when it would not be proper to declare a cash dividend. The assets must exceed all liabilities, and in determining the existence of a surplus available for dividends, all capital stock that has been issued must be considered as a liability.

CLOSING TRANSFER BOOKS

=21.= In large companies it is customary for the board of directors to close the stock transfer books a certain number of days prior to the date of payment of a dividend, for the purpose of obtaining the names and addresses of all stockholders. Notices are then sent to all stockholders that a dividend will be paid on a certain date and that the transfer books will be closed for a stated period. Transfer books are also frequently closed for a certain period prior to the annual meeting of the stockholders. The laws of some states provide that only those stockholders whose names have appeared as stockholders on the books of the company for at least thirty days prior to the date of the annual meeting, shall be entitled to vote at said meeting.

STOCKHOLDERS' MEETINGS

=22.= Meetings of stockholders are, as a rule, held annually, and the date of such meeting is usually specified in the charter. At the annual meeting the board of directors presents, through its president or other officer, a report of the business for the year, accompanied by a financial statement. At this meeting the stockholders elect directors to take the place of those whose terms of office have expired. A stockholder may vote at stockholders' meetings either in person or by proxy, and is entitled to one vote for each share of stock registered in his name at the time of the meeting. Notice of a stockholders' meeting must in all cases be mailed to each stockholder at his last known address, a certain number of days prior to the date of the meeting. This notice is mailed by the secretary of the company.

SALE OF STOCK BELOW PAR

=23.= Many corporations formed to carry on business of a speculative nature find it difficult to sell stock at par. This is especially true when the assets consist largely of patents, an undeveloped mine, or property of a similar nature. It has become the custom for corporations to take over such properties, issuing in payment for the same full paid stock greatly in excess of its value. The original owners of the property will in turn donate a certain portion of the stock to the corporation to be sold to provide working capital. This stock then becomes treasury stock and is offered for sale at a liberal discount. The selling of property to a corporation at an inflated value is called the process of watering the stock. It can only be justified when an uncertainty exists as to the actual value of the property acquired. In the purchase of a going business, the real value of the goodwill is largely a matter of opinion, and the judgment of the board of directors of a corporation making such a purchase must be considered as final.

CORPORATION BOOKKEEPING

=24.= Bookkeeping for a corporation as a record of its business transactions with the public is not different than bookkeeping for a single proprietorship or a partnership. There are, however, certain necessary records peculiar to a corporation, including accounts of a financial nature between the corporation and its stockholders. It is with these records and accounts that we are concerned in this discussion of corporation bookkeeping.

=25. Books Required.= The books required for corporation records are, _Stock Certificate Book_, _Stock Transfer Book_, _Stock Ledger_, _Minute Book_, (and in certain cases, _Installment Book_, _Stock Register_, and _Dividend Book_). These are auxiliary books and are known as _stock_ books.

_Stock Certificate Book._ This is a book of stock certificates, with stubs giving full particulars of each certificate issued. When a stock register is used, the record is posted to it from the stub, otherwise posting is made direct from the stub to the stock ledger.

_Stock Transfer Book._ This is a book in which is kept a record of all transfers of stock. Each entry is practically a copy of the form of assignment found on the back of the stock certificate. It is supposed that each transfer will be signed by the one transferring the stock, but frequently when certificates are presented with the proper endorsement, the transfer is signed by the one making the transfer as _attorney in fact_. The transfer book is made with two, and sometimes three, transfers to a page. Transfers are posted to the stock register, when used, or direct to the stock ledger.

_Stock Ledger._ This is the book in which an account is kept with each stockholder showing the number of shares held by him. Sometimes the amount is included. When a stockholder receives a certificate of stock it is posted to the credit side of his account in the stock ledger. When he transfers a certificate it is posted to the debit side of his account. A trial balance of the stock ledger should be taken at stated periods, for the stock standing to the credit of the stockholders should equal the total stock outstanding. The stock ledger is supposed to show only the stock issued and the names of its holders. For example, if the authorized stock of a corporation is 1,000 shares and there remains 300 shares unsubscribed, the stock ledger will show 700 shares--the total issued--to the credit of individual stockholders. An account should be opened in the stock ledger with _Capital Stock_, which account will be debited with all stock issued. This is in effect a representative account since it represents the total stock that should stand to the credit of other accounts in the stock ledger.

_Minute Book._ This is a record book in which the secretary keeps records or minutes of the proceedings of all stockholders' and directors' meetings. This is an official record of the acts of the corporation, and is frequently called for to be introduced in court as evidence. The secretary is custodian of the minute book and should see that it is carefully preserved.

_Installment Book._ When stock subscriptions are payable in installments, a form of receipt called a scrip or installment certificate is issued. As payments are made they are endorsed on the back of this certificate, and when all payments have been made the scrip is exchanged for a regular stock certificate. These scrip certificates are bound in book form similar to stock certificates.

Sometimes the scrip certificate takes the form of an installment receipt for the amount paid, all receipts being surrendered to the company when payments have been completed.

_Stock Register._ Some large corporations keep, in addition to the stock ledger and transfer books, a stock register which is a complete register of all stock issued. This book is kept by the _registrar_--usually a trust company or bank. All certificates are entered in the register in numerical order and full particulars of each are given. When a transfer is made both the old and new certificates must be taken to the registrar, who cancels the old and places his indorsement on the new, certifying that it has been registered.

One purpose of having a registrar is to prevent an over-issue of stock. The number of shares shown on the register must not exceed the number of shares which the corporation is authorized to issue.

_Dividend Book._ When the directors declare a dividend it is necessary to make a list of stockholders entitled to receive a dividend. Large corporations use a special form similar to the one illustrated. It is made either in a book or on loose sheets which are placed in a binder.

Some stockholders issue written orders to pay all dividends to some other person, which makes it necessary to record on this list the name of the person to whom this dividend is payable, as well as the name of the stockholder.

OPENING ENTRIES

=26.= In opening the books of a corporation it is necessary to first get the capital entered. In a proprietorship, the capital is credited to the owner; in a partnership it is credited to the individual partners. On the books of a corporation an account called capital stock is opened, to which capital is credited. This account is opened in the general ledger and original entries are made in the journal. The manner of making the opening entries depends upon the method of disposing of the capital stock.

_If stock is sold for cash only_ and the entire amount is subscribed and paid for, the entry is simply

Cash $100,000
To capital Stock $100,000
Stock subscribed and paid
for by the following:
John Doe $50,000
Richard Roe 25,000
Henry Snow 25,000
as per subscription
list dated--------190----.

_If only a part of the authorized stock is subscribed_, there are two methods of entering the transaction.

First: Debit cash and credit capital stock as above, only as fast as
stock is subscribed and paid for.

Second: Debit cash and credit capital stock for the amount actually
subscribed and paid for. Debit a new account called _unsubscribed
stock_ and credit capital stock for the balance of the total
authorized issue of stock.

Illustrating the above, we will suppose that the National Manufacturing Co. is organized with a capitalization of $100,000, of which $50,000 is subscribed and paid for in cash. The entries would be:--

Cash $50,000
To capital stock $50,000
Stock subscribed and paid
for by the following:
John Doe $25,000
Richard Roe 15,000
Henry Snow 10,000
--------
Unsubscribed stock 50,000
To capital stock 50,000

_If stock is not paid for when subscribed_ or if it is payable in installments the entry is:

John Doe 25,000
Richard Roe 15,000
Henry Snow 10,000
To capital stock 50,000
For subscription to stock
as per subscription list.

Or if it is not desired to enter the names of the subscribers an account is opened in the name of _subscriptions_, and the entry is:

Subscriptions 50,000
To capital stock 50,000

The above entries at once place the entire authorized capital stock on the books. When further subscriptions are made, subscription account is debited and unsubscribed stock is credited. When subscriptions are paid, cash is debited and subscriptions credited.

When subscriptions are payable in regular installments, payments may be credited to subscriptions. The plan is sometimes followed, however, of opening an account for each installment, as Installment No. 1, to which payments are credited. When the installment is fully paid this account would be closed into subscription account.

Or still another formula--when stock has been sold _subject to assessments to be made by the board of directors_, and an assessment has been called the entry is:

Assessment No. 1. $10,000
To subscriptions $10,000
An assessment of 20%
as per resolution of
the board of directors
John Doe 5,000
Richard Roe 3,000
Henry Snow 2,000

When paid, cash is debited and assessment No. 1 is credited. When the next assessment is called an account is opened with assessment No. 2.

=27. When a Part of the Stock is Paid for in Property and the Balance in Money.= A corporation known as The National Manufacturing Company is formed to take over a manufacturing business owned by John Doe. The capital stock is $100,000 of which Mr. Doe is to receive $50,000 for the assets and goodwill of his business, the company agreeing to assume his liabilities. His statement of affairs shows the following:

_Assets_
Cash in bank $2,264.00
Accounts receivable 4,650.50
Machinery 9,000.00
Manufactured goods 2,100.00
Material and supplies 3,780.00
Furniture and fixtures 700.00 $22,494.50
--------
_Liabilities_
Accounts payable 864.20 864.20
-------- --------
21,630.30

Since the net assets are $21,630.30, and the stock to be issued to John Doe is $50,000 the difference, or $28,369.70, represents the amount paid for the goodwill of the business.

The transaction is entered as follows:--

Property and Goodwill of
the business of John Doe,
transferred to this company as
per resolution of the board
of directors, Dec. 21st, 1908.

Goodwill $28,369.70
Cash 2,264.00
Accounts receivable 4,650.50
Machinery 9,000.00
Manufactured goods 2,100.00
Material and supplies 3,780.00
Furniture and fixtures 700.00
Accounts payable $864.20
Capital stock 50,000.00

One half of the capital stock is thus accounted for. The balance is to be subscribed, and when subscribed the entries will be as explained in Art. 26, depending upon whether subscriptions are paid in full or in installments.

=28. When Stock is Issued in Payment of Property and a Part of the Stock is to be Donated to the Company.= John Doe owns a valuable patent on an automobile attachment and desires to secure capital to carry on its manufacture. He interests Richard Roe and Henry Snow, who agree to assist him to form the National Manufacturing Company to take over his patent and manufacture the attachment. The company is incorporated with an authorized capitalization of $150,000. Roe and Snow agree that Doe shall receive $100,000 full paid stock for his patent, and to subscribe $25,000 each, payable in cash to be used for the purchase of the necessary machinery. John Doe, in turn, agrees to donate $50,000 of his stock to provide working capital. The entries are:

Patents $100,000
Capital stock $100,000
Full paid stock issued to
John Doe to pay for
patents transferred to the
Company by bill of sale dated
Dec. 2, 1908.

Subscriptions $50,000
Capital stock $50,000
Subscriptions to capital
stock as follows:--
Richard Roe $25,000
Henry Snow 25,000
--------
Treasury stock 50,000
Working capital 50,000
Full paid stock donated
by John Doe to provide
working capital.

When subscriptions are paid:--

Cash 50,000
Subscriptions 50,000

It is decided to sell $30,000 of the treasury stock at 50% of its face value, and subscriptions are received for this amount.

Subscription to treasury stock 30,000
Treasury stock 30,000

Subscription account is debited and treasury stock credited for the full amount since this is the amount of full paid stock to be issued, regardless of the price at which it is sold.

When this stock is paid for, the entry in the cash book on the debit side is:

Subscriptions to treasury stock 15,000

This leaves a debit balance of $15,000 in the account _subscriptions to treasury stock_, which represents a discount on the stock sold.

The manner of disposing of this discount depends upon the provisions made by the directors in respect to the creating of working capital.

If their resolution provides that the fund maintained for working capital shall be only such an amount as may be realized from the sale of treasury stock, the discount is disposed of by the following entry:

Working capital 15,000
Subscriptions to treasury stock 15,000
Discount on 30,000 treasury
stock sold.

Suppose, however, that the directors have provided by resolution for the maintaining of a working capital of $50,000. In that case the liability for the full $50,000 must remain on the books until such time as other provision is made. The entry would then be:

Bonus $15,000
Subscriptions to treasury stock $15,000

The discount is, to all intents, a bonus given to the purchasers, and if, as frequently happens, purchasers are promised a bonus of a share of stock for every share purchased, it would be proper to make the following entry in the first place.

Subscriptions to treasury stock 15,000
Bonus 15,000
Treasury stock 30,000
Sold 30,000 treasury stock at 50%
of face value.

In any dividend distribution the purchasers are entitled to draw dividends on the face value of their stock, since it was issued to them as full paid. It would be manifestly unfair to charge the discount or bonus against profits for the current year, and it is customary to spread it over a period of several years, charging off a certain per cent each year. The bonus account is, in the meantime, carried on the books as an asset, and belongs in the class known as _fictitious_ assets.

Treasury stock is an asset, its real value being the market value of the stock represented. In the event of liquidation of the company, treasury stock would off-set the liability on account of capital stock. When all of the treasury stock is sold the account closes itself; or if it is issued to stockholders in the form of stock dividends, it is closed into profit and loss.

Working capital is a liability, which may be termed an _assumed_ or _nominal_ liability. Like capital stock it is a liability only as between the company and its stockholders. It off-sets whatever form of asset--cash or otherwise--that represents proceeds from the sale of treasury stock. The real position of working capital in the balance sheet is that of a capital liability which must be considered before any surplus available for dividends can be said to exist. Power is usually given the directors to reserve a certain amount for working capital, and even though an actual surplus may exist they have the right to off-set this with a working capital liability instead of declaring a dividend.

=29. Premium on Stock.= The stocks of many well-managed enterprises sell at a premium. In all such cases the amount received above the par or face value is credited to an account called _premium on stock_. At the end of the year this account is closed into surplus account. If any such items are standing on the books it can be used to off-set bonus account or organization expenses. It is not proper to close premium account into the current profit and loss account, for while it represents a profit, it is not earned in the regular operations of the business.

=30. Reduction of Working Capital.= As before stated, so long as working capital remains on the books it must be treated as a liability. Having the right to create working capital, the directors also have the right to reduce it whenever, in their judgment, the necessities of the business no longer require its maintenance in the original amount.

A reduction of working capital has the effect of increasing surplus, since surplus is increased by an increase of assets or a decrease of liabilities. To reduce working capital, the account is closed into surplus. It is perhaps necessary to say that the account should not be closed into profit and loss, since it does not represent current profits.

Suppose that in the case of the National Manufacturing Co., it is desired to reduce working capital from $50,000 to $25,000; the entry would be:

Working capital $25,000
Surplus $25,000
Working capital reduced by
resolution of the board of
directors, January 15th, 1909.

ENTRIES IN STOCK BOOKS

=31.= The entries in the stock books are very simple and are just the opposite of stock entries in the general or financial books of the company. When certificates of stock are issued, an account is opened in the stock ledger with each stockholder, to which is credited the stock issued to him. At the same time an account is opened in this ledger with capital stock which is debited with all stock issued, thus preserving the balance of the stock ledger. Taking the example in Art. 26, when stock is issued--

We debit--
Capital stock $150,000
We credit--
John Doe $100,000
Richard Roe 25,000
Henry Snow 25,000

When the $50,000 stock is donated to the treasury to provide working capital--

We debit
John Doe 50,000
We credit
Treasury stock 50,000

and open an account with treasury stock in the stock ledger.

When treasury stock is sold--

We debit
Treasury stock 30,000
We credit
Subscribers 30,000

When a stockholder sells a part or all of his shares to another it has no effect on capital stock or treasury stock accounts in the stock ledger. The only change takes place in the accounts of the individual stockholders involved. The stock transferred is debited to the account of the _transferor_, and credited to the account of the _transferee_.

Supposing that $30,000 treasury stock was purchased by Henry Benson, George Dennis, and Richard Carpenter, each purchasing $10,000, the stock ledger and stock register--if one is used--would appear as shown in the illustration. Footing the two sides of the stock register we find a balance of 1,300 shares which is the actual amount outstanding, the balance of 200 shares remaining in the treasury. A trial balance also shows that the stock ledger balances with a credit of $20,000 treasury stock.

EXERCISES

1. A corporation is organized with a capital of $50,000.00, divided into 500 shares of $100.00 each. The corporation begins business when 250 shares have been subscribed for. Of this amount _A_ subscribes for 100 shares, _B_ for 100 shares, and _C_ for 50 shares. These shares are paid for in cash within 30 days after the date of subscriptions.

Six months later the balance of the stock is subscribed for, subscriptions being received from _A_ for 50 shares, _B_, 50 shares, _D_, 100 shares, and _E_, 50 shares. _C_ sells 50 shares to _B_. These new shares are paid for in cash.

Make all entries in general books.

Make all entries in stock books.

2. _A_, _B_, and _C_ organize a corporation with an authorized capitalization of $100,000.00, divided into 1,000 shares of $100.00 each. _A_ subscribes for 400 shares, _B_, 300 shares, and _C_, 200 shares. The corporation buys from _D_ land and buildings for $20,000.00, paying him $10,000.00 in cash and issuing to him 100 shares of stock.

Subscriptions are paid as follows: _A_ pays $20,000.00 cash and gives his note due in 60 days for $20,000.00; _B_ pays $20,000.00 cash and gives his note for $10,000.00 payable in 30 days; _C_ pays $10,000.00 cash and gives his note for $10,000.00 payable in 10 days.

Make all entries in journal and cash book and post to ledger.

NOTE.--Land and buildings are grouped under the head of real estate.

3. John Davis and Daniel Greene own the La Belle mine, and to secure capital for its development they decide to organize a mining company and to sell shares. A corporation is organized with a capitalization of $1,000,000.00 in shares of $1.00 each. Of this stock 999,000 shares are issued to Davis and Greene, each receiving an equal number, and they, in turn, deed the La Belle mine to the company. The remaining 1,000 shares are subscribed and paid for by Martin Otis. Davis and Greene donate to the treasury 49,800 shares to be sold for the purpose of securing working capital. The directors, by proper resolution, decide to sell 200,000 shares: 50,000 shares to be sold at 20 cents on the dollar, 50,000 shares at 25 cents, and 100,000 shares at 35 cents. The resolution also provides that the corporation's liability for working capital shall be no more than the amount realized from the sale of treasury stock. Subscriptions are received for the 200,000 shares and payments are made at the prices specified.

Make all necessary entries to get these transactions properly recorded on both the general and stock books.

STOCK ISSUED FOR PROMOTION

=32.= Frequently when a corporation is organized, stock is issued to a promoter as payment for his services. An enterprise may have great latent possibilities provided sufficient capital can be secured for its development, but until the possibilities for making a profit can be clearly shown, it is difficult to interest the investing public. To interest investors in an enterprise yet to be developed requires a special talent not possessed by the average owner of a patent, mine, or process. There are men who possess this special talent and who make a business of promoting companies.

In many cases--probably most cases--the owner of the thing to be promoted has no money with which to pay the promoter. Consequently, the promoter first satisfies himself that the enterprise actually holds possibilities of profit and then agrees to accept all or a part of his fees in the stock of the company. The portion of his fee that he is willing to accept in stock, and the number of shares demanded, is governed largely by his own faith in the enterprise. His fee may be a certain per cent on the stock sold, or it may be an arbitrary sum represented by a certain number of shares. When he accepts his entire fee in stock, it may represent from 25 per cent to 50 per cent of the entire capitalization, and while the fee may appear exorbitant when represented by the par value of the stock, its actual value to him is represented by the _real_ value of the stock, or the price at which he could sell it.

Volumes might be written on the subject of promotion, but our special concern is the proper treatment of promotion fees on the books of the company. Strictly speaking, promotion fees are as much an expense as the cost of printing the company's prospectus, but to immediately charge it to expense would, in many cases, cause the accounts to show an impairment of capital at the outset. Suppose, for example, that a corporation is organized with a capital of $100,000.00 all paid in cash. The promoter is paid a fee of $15,000.00. Profits earned--trading profits--in the first year are $8,000.00, but we have a charge of $15,000.00 for promotion in the expense account. The books show that the company is insolvent, the liabilities being $7,000.00 in excess of the assets, while the business actually is in a healthy condition.

Expenses paid in the regular course of business are expected to be off-set by earnings. When we pay rent for a store or office we expect that, by reason of our occupancy of that store or office as a place of business, our earnings will be increased in an amount greater than that paid for rent. Promotion expense cannot, in itself, produce earnings. The cash, or other form of asset, received from the sale of stock--the direct result of promotion expense--is off-set by the stock liability created. Earnings to off-set promotion expense must come from future operations of the business.

It has become quite the general custom, therefore, to allow the expense incident to the organization of the company to stand on the books as a fictitious asset, under some such caption as _promotion expense_, _promotion fund_, or _organization expense_. The amount is gradually reduced by charging a stated per cent to profit and loss each year.

There is another special reason why it would be manifestly unfair to immediately charge promotion fees to expense. Suppose a promoter receives 20% of the stock for his services, while the holders of the remaining 80% have paid cash for their shares. Since the 80 per cent paid in cash must earn dividends on the entire 100 per cent of stock, it would be unjust to the holders of the 80 per cent to withhold dividends until the par value of the 20 per cent of stock shall have been added to the assets of the company from profits earned.

=The Entry.= A patent is owned by Geo. Davis, who secures the services of Wm. Lane to promote a company to undertake its manufacture. The corporation is capitalized at $500,000.00. Davis sells the patent to the company receiving $250,000.00 stock in payment, and Lane receives $25,000.00 stock for promotion, when he has secured subscriptions for the remaining $225,000.00 at par. The entries to record the issue of stock to Lane for promotion are:

Subscriptions $25,000.00
Capital stock $25,000.00
Subscription of
Wm. Lane

Promotion expense 25,000.00
Wm. Lane 25,000.00
Fee due Wm. Lane for
promotion of company
and sale of stock.
--------
Wm. Lane 25,000.00
Subscriptions 25,000.00
Amount due to Lane credited
to subscriptions to pay for
stock subscribed by him.

The entries for the shares issued to Davis and those sold are the same as previously explained and illustrated.

SURPLUS AND DIVIDENDS

=33.= The directors are under no obligation to distribute in dividends the profits earned in any one year. Instead, the by-laws usually provide that the decision as to when a dividend shall be declared is to be left entirely to the directors. They have it in their power to retain of the profits such an amount as, in their judgment, is advisable or necessary to safeguard the interests of the company. At the close of the fiscal year it is customary to close profit and loss account, and in a corporation it is closed into surplus.

=34. Surplus Sub-divided.= Sometimes the term surplus is used to designate a part of the profits set aside for a special purpose, as the creation of a fund to meet an obligation falling due at some future date. When surplus is treated as a special fund, or when it has been provided by resolution of the directors "_that a certain sum, or a certain per cent of the profits shall be set aside as a surplus fund_," and remaining profits not distributed as dividends may be placed to the credit of an account called _Undivided Profits_ or _Undistributed Profits_.

In reality undivided profits is surplus, and the division of the account merely serves to show that the amount credited to surplus is for some reason reserved, while the amount credited to undivided profits is available for dividends whenever the directors may so elect. Whether or not the surplus should be shown in the balance sheet under these various headings, or all under the general head of surplus, with explanatory notes, is a question which need not concern us at this point.

=35. Declaring a Cash Dividend.= When a dividend is declared an account should be opened under the caption _Dividends Payable_ or _Dividend No. 1._, etc. We will suppose that a dividend has been declared out of the profits of the business for the current year. The entry is:--

Profit and Loss
Dividends payable
Dividend of----% declared
by the board of directors
--------1909, payable--------1909.

When the dividend is paid the entry will be--

Dividends payable
Cash
To pay dividend payable
--------1909.

=36. Declaring a Stock Dividend.= Not all dividends are paid or payable in cash. Sometimes the directors declare a dividend payable in stock and this is known as a stock dividend. There may be treasury stock in possession of the treasurer, and if the books show a surplus, which would make it proper to declare a cash dividend, a dividend may be declared payable in treasury stock. When such a dividend is declared the entry is--

Profit and Loss
Stock dividend
A dividend of----% declared
by the board of directors
--------1909 payable--------1909,
payment to be made in
treasury stock
Stock dividend
Treasury stock
To pay stock dividend
declared--------1909.

The shares are then transferred on the stock books debiting treasury stock and crediting stockholders.

It is not absolutely necessary that a company possess treasury stock to declare a stock dividend. When current profits are large or a surplus, larger than the requirements of the business demand, has been accumulated, a stock dividend may be declared by issuing additional shares, provided the original stock has not all been subscribed for.

If a large surplus has been accumulated and a part of the stock is unsubscribed, a stock dividend would require the following entries:

Surplus
Stock dividend
A stock dividend of----%
declared by the directors--------1909
payable in the unissued
stock of this company.
--------
Subscriptions
Capital stock
Additional stock subscriptions
received from the following.
--------
Stock dividends
Subscriptions
Stock dividend due stockholders
used to off-set subscriptions.

The stock dividend is a device frequently used to conceal actual profits, or to cover up the fact that dividends are being declared in excess of a fixed rate. This is especially true of such public service corporations as lighting companies or street railways. In many cases a company will go through the necessary formalities to increase its capital stock for the purpose of absorbing surplus by means of a stock dividend.

=37. Treatment of a Loss.= If, during any year, the business has sustained a loss, it will, of course, appear as a balance on the debit side of profit and loss account. This will then be transferred to the debit of undivided profits or surplus, if any, remaining from previous years. For illustration, suppose the books show a surplus of $5,000.00, undivided profits $500.00, loss for the current year $2,500.00, the entry will be:--

Undivided profits $500.00
Surplus 2,000.00
Profit and loss $2,500.00
Loss for the year.

If there is no surplus remaining from former years, the business is insolvent, in which case the capital is said to be impaired. This can be taken care of in either of two ways. First--by the stockholders subscribing to a fund to cover the deficiency. Second--by a reduction of the capital stock.

EXERCISES

1. David Francis and Henry Harmon own a large tract of timber land in Mexico. In connection with F. B. Walker--a promoter--they organize a corporation to build railways and mills for the purpose of developing the property and to market the timber. The company is capitalized for $1,000,000.00. The land is sold to the corporation for $1,000,000.00, stock for that amount being issued to Francis, Harmon, and Walker. Francis and Harmon each received $400,000.00 and Walker, $200,000.00. This $200,000.00 stock is issued to Walker as his fee for promoting the company. Francis and Harmon each donate 250 shares, of the par value of $100.00 each, to the treasury to be sold to produce working capital.

Make all necessary entries in general books.

2. The profits of a manufacturing company with a paid up capital of $100,000.00, are $9,765.00. The directors, by proper resolution, declare a cash dividend of 6 per cent, set aside a surplus of $3,000.00, and transfer the balance to undivided profits.

Make all necessary entries in general books, showing ledger accounts after payment of dividends.

3. The following year's business of the above company showed a loss of $2,160.00. How is this loss disposed of? Make entries.

4. A company capitalized at $250,000.00 has sold $100,000.00 of its stock, the balance being unsubscribed. Its accumulated surplus is $90,000.00, and the directors declare a stock dividend of 50 per cent to all stockholders. Make all entries.

5. A manufacturing company has a capital stock of $100,000.00. One item in its assets is machinery $26,750.00. The profits for the year are $11,640.00. The directors provide for a reserve for depreciation of machinery of 10% and declare a dividend of 5%.

Make all entries.

CHANGING BOOKS FROM A PARTNERSHIP TO A CORPORATION

=38.= Wilson, Brackett, and Nixon have been conducting a retail clothing business under a partnership agreement. Appreciating the advantages of a corporate form of organization, they decide to incorporate under the name of the Continental Clothing Company.

The first step necessary to prepare for the incorporation of a partnership is to ascertain the net capital of the business as it stands. Accordingly, an inventory is taken, the books are closed, and a balance sheet prepared with the following results:

_Balance Sheet of Wilson, Brackett, and Nixon_
_Assets_
Cash $1,650.72
Bills receivable $1,725.00
Accounts receivable 3,264.18 4,989.18
--------
Merchandise inventory 10,450.00
Furniture and fixtures 4,000.00 14,450.00 $21,089.90
-------- --------
_Liabilities_
Bills payable 3,000.00
Accounts payable 2,089.00 5,089.90
--------
Wilson, capital account 7,000.00
Brackett, capital account 5,000.00
Nixon, capital account 4,000.00 16,000.00 21,089.90
-------- --------

From this balance sheet it is seen that the net capital is $16,000.00, of which Wilson owns $7,000.00, Brackett, $5,000.00, and Nixon, $4,000.00. On this showing, it is decided to form the company with a capital stock of $20,000.00, all of which is to be issued as full paid stock to the partners in proportion to their interests in the partnership.

New books are opened for the corporation and the next step is to transfer the accounts of the partnership to the corporation. An account is opened in the partnership ledger with the Continental Clothing Company and the following entry is made:

Continental Clothing Co. $21,089.90
Cash $1,650.72
Bills receivable 1,725.00
Accounts receivable 3,264.18
Merchandise inventory 10,450.00
Furniture and fixtures 4,000.00

The above entry closes all of the asset accounts and shows that they have been transferred to the new company.

The next entry is:

Bills payable $3,000.00
Accounts payable 2,089.90
Wilson 7,000.00
Brackett 5,000.00
Nixon 4,000.00
Continental Clothing Co. $21,089.90

The above entry closes the liability and partners' accounts showing that they have been transferred to the new company and also closes the account of the Continental Clothing Co.

=39. Entries on the Corporation Books.= We are now ready to open the books of the new company. Subscription books are opened and the following subscriptions are received:

Wilson 8,750.00
Brackett 6,250.00
Nixon 5,000.00

The net assets of the partnership are $4,000.00 less than the capital stock of the new company. No money is to be invested to cover this discrepancy, so it will be necessary to account for it on the books by opening a fictitious asset account under some such name as _goodwill_. Having made this provision, the books of the new company are opened by the following entries:

Subscriptions 20,000.00
Capital stock 20,000.00
Subscriptions received
as per subscription books.
--------
Cash 1,650.72
Bills receivable 1,725.00
Accounts receivable 3,264.18
Merchandise inventory 10,450,00
Furniture and fixtures 4,000.00
Goodwill 4,000.00
Bills payable 3,000.00
Accounts payable 2,089.90
Subscriptions 20,000.00

The business and goodwill of the
firm of Wilson, Brackett, and
Nixon transferred to this company
in payment of subscriptions
to capital stock.

These entries serve to get the capital stock, also the assets and liabilities of the partnership properly recorded on the books of the new company.

STOCK DONATED TO EMPLOYES

=40.= A partnership composed of Benson, Black, and Mabley is conducting a retail hardware business. They desire to give their bookkeeper (Parker) an interest in the business. The firm has the following assets and liabilities:

_Assets_
Cash $3,000.00
Accounts receivable 2,000.00
Merchandise 15,000.00
Total assets $20,000.00
_Liabilities_
Accounts payable 2,000.00
Benson capital 6,000.00
Black capital 6,000.00
Mabley capital 6,000.00
Total liabilities 20,000.00

They incorporate the Benson Company with a capitalization of $40,000.00 divided into 400 shares of $100.00 each. Benson, Black, and Mabley each subscribe for 100 shares, and 20 shares are presented to Parker. The balance of the stock is to remain unsubscribed until such time as it is decided to accept further subscriptions. The business of the partnership is to be accepted by the company in payment of subscriptions which have been made, and which are for 320 shares or $32,000.00. The net assets of the partnership being $18,000.00, goodwill must represent the balance of $14,000.00. The entries on the books of the partnership follow--

The Benson Co. $20,000.00
Cash $ 3,000.00
Accounts receivable 2,000.00
Merchandise inv. 15,000.00
--------
Accounts payable 2,000.00
Benson 6,000.00
Black 6,000.00
Mabley 6,000.00
The Benson Co. 20,000.00

=41. On Books of the Benson Co.= The entries on the books of the new company are the same as in previous illustrations, the stock donated to Parker having been a gift from the partnership and the amount included in the goodwill.

Subscriptions 32,000.00
Capital stock 32,000.00
--------
Cash 3,000.00
Accounts receivable 2,000.00
Merchandise inventory 15,000.00
Goodwill 14,000.00
Accounts payable 2,000.00
Subscriptions 32,000.00

=42. When the Gift is Made by an Existing Corporation.= We will suppose that the Benson Co. wishes to donate 10 shares of stock to each of three employes, _A_, _B_, and _C_. Having 80 shares unsubscribed, the donation will be made from that stock. Supposing that the company has accumulated a surplus, the transaction will be entered on the "books" as follows: