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Corporations
Advantages of Corporations
Owners' personal assets are protected from
business debt and liability
Corporations have unlimited life extending beyond
the illness or death of the owners
Tax free benefits such as insurance, travel, and
retirement plan deductions
Transfer of ownership facilitated by sale of stock
Change of ownership need not affect
management
Easier to raise capital through sale of stocks and
bonds
Disadvantages
More expensive to form than
proprietorship or partnerships
More legal formality
More state and federal rules and
regulations
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Different kind of Stocks
There are thousands of stocks to choose from, so investors usually like to
put stocks into different categories: size, style and sector. Thinking of
stocks this way helps you diversify - that is, to choose several stocks that
are different enough from each other that they won't all tank at the same
time.
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Different kind of Stocks
Stock typically takes the form of shares of either common stock
or preferred stock.
Common stock typically carries voting rights that can be exercised in
corporate decisions.
Preferred stock differs from common stock in that it typically does not
carry voting rights but is legally entitled to receive a certain level
of dividend payments before any dividends can be issued to other
shareholders.
Convertible preferred stock is preferred stock that includes
an option for the holder to convert the preferred shares into a fixed
number of common shares, usually any time after a predetermined date.
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Cumulative Dividend
Preferred stock often contains a cumulative dividend feature. This means
that preferred stockholders must be paid both current-year dividends and
any unpaid prior-year dividends before common stockholders receive
dividends. When preferred stock is cumulative, preferred dividends not
declared in a given period are called dividends in arrears.
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Different kind of Stocks
Convertible preferred
stock is preferred stock that includes an option for the holder to convert
the preferred shares into a fixed number of common shares, usually any
time after a predetermined date.
Cumulative dividends
Cumulative stockholders must be paid dividends for present and previous
years before commons stockholders get paid for dividends.
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Issuance of Stock
A corporation can issue common stock directly to
investors. Or it can issue the stock indirectly
through an investment banking firm that specializes
in bringing securities to market.
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Market Value of Stock
The stock of publicly held companies is traded on organized exchanges.
The interaction between buyers and sellers determines the prices per
share. In general, the prices set by the marketplace tend to follow the
trend of a company's earnings and dividends. But, factors beyond a
company's control, such as an oil embargo, changes in interest rates, and
the outcome of a presidential election, may cause day-to-day fluctuations
in market prices.
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Market Value of Stock
A recent stock quote for PepsiCo, listed on the NYSE under the ticker
symbol PEP, is shown below.
Stock Volume High Low Close Net Change
PepsiCo 4,305,600 60.30 59.32 60.02 +0.41
These numbers indicate that PepsiCo's trading volume was 4,305,600
shares. The high, low, and closing prices for that date were
$60.30, $59.32, and $60.02, respectively. The net change for the day was
an increase of $0.41 per share.
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Treasury Stocks
Treasury stock is a corporation’s owned stocks
that have been reacquired by the corporation
and is been held for future use.
1. To share with officers and employees
2. To increase trading and confident
3. To acquire other companies
4. Increase earning per share
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Stock dividends and splits
Stock dividends is a pro rata distribution of
the corporation own stocks to stockholders.
Cash dividends is a pro rata distribution of
cash to stockholders.
Stock splits is issuing of additional shares of
stocks to stockholders according to the %.
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Paid-in capital
Retained Earning
Paid-in capital is the total amount of cash and other assets paid in to the
corporation by stockholders in exchange for capital stock. As noted
earlier, when a corporation has only one class of stock, it is common
stock.
Retained earnings is net income that a corporation retains for future
use.
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Stock Transactions
Sale 2k shares of $1 par value for at par.
Cash 2,000
Common Stock 2,000
Sale 2K shares of $1 par value for $5ea.
Cash 10,000
Common Stock 2,000
Paid in capital in excess 8,000
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Journal Entry Ex.
Acker Inc. issues 4,772 shares of $96 par value preferred stock for cash
at $145 per share. Journalize the issuance of the preferred stock.
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Why do differences exist?
Company Net Income Net Cash Provided by Operating A.
Kohl's Corporation $ 1,083 $ 1,234
Wal-Mart Stores, Inc. 11,284 20,164
J. C. Penney Inc. 1,153 1,255
Costco Corp. 1,082 2,076
Target Corporation 2,849 4,125
The differences are explained by differences in the timing of the
reporting of revenues and expenses under accrual accounting versus
cash. Under accrual accounting, companies report revenues when
earned, even if cash hasn't been received, and they report expenses when
incurred, even if cash hasn't been paid.
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Cash flow from operating
Why does GM's cash provided by operating activities drop so
precipitously when the company's sales figures decline?
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Indirect and Direct
Methods
In order to perform step 1, a company must convert net income from
an accrual basis to a cash basis.
The indirect method adjusts net income for items that do not affect cash.
A great majority of companies (98.8%) use this method, as shown in the
nearby chart.1 Companies favor the indirect method for two reasons: (1)
It is easier and less costly to prepare, and (2) it focuses on the differences
between net income and net cash flow from operating activities.
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Cashflow -Teamwork
The net income for Adcock Co. for 2010 was $279,013. For 2010
depreciation on plant assets was $65,978, and the company incurred a
loss on sale of plant assets of $13,993. Compute net cash provided by
operating activities under the indirect method.
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Solution
Cash flows from operating income
Net income $279,013
Adjustments to reconcile net income
to net cash provided by operating activities
Depreciation expense $65,978
Loss on sale of plant assets 13,993
79,971
Net cash provided by operating activities $358,984
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Internal Controls
Internal Controls consist of all the related
methods and measures adopted within an
organization to safeguard its assets, enhance
the reliability of its accounting records,
increase efficiency of operations, and ensure
compliance.
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Reconciliation of Bank Balances
1.DEPOSITS IN TRANSIT. End-of-month deposits of cash recorded on the depositor's books in
one month are received and recorded by the bank in the following month.
2. OUTSTANDING CHECKS. Checks written by the depositor are recorded when written but
may not be recorded by (may not “clear”) the bank until the next month.
3. BANK CHARGES. Charges recorded by the bank against the depositor's balance for such
items as bank services, printing checks, not-sufficient-funds (NSF) checks, and safe-deposit box
rentals. The depositor may not be aware of these charges until the receipt of the bank statement.
4. BANK CREDITS. Collections or deposits by the bank for the benefit of the depositor that may
be unknown to the depositor until receipt of the bank statement. Examples are note collection for
the depositor and interest earned on interest-bearing checking accounts.
5. BANK OR DEPOSITOR ERRORS. Errors on either the part of the bank or the part of the
depositor cause the bank balance to disagree with the depositor's book balance.
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Sample Bank Reconciliation
Nugget Mining Company's books show a cash balance of $20,502. The bank statement
shows an ending balance of $22,190. Identified the following reconciling items.
1. Deposit of 3,680 does not appear on the bank statement.
2. Checks written in transit. Ck. 7327-$150, ck.7348-$4820, ck.7349-$31
3.Not yet recorded the $600 of interest collected by the bank.
4. Bank service charges of $18 are not yet recorded on the books.
5. The bank returned customer's checks for $220 with the bank statement, “NSF.”
6. Incorrectly recorded check #7322, written in November for $131 in payment of an
account payable, as $311.
7. A check in the amount of $175 that the bank incorrectly charged to Us accompanied
the statement.
7. ($21,044)
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Accounts Receivables
vs. Note Receivable
Accounts receivable are oral promises of the purchaser to pay for goods
and services sold. They represent “open accounts” resulting from short-
term extensions of credit. A company normally collects them within 30
to 60 days.
Notes receivable are written promises to pay a certain sum of money on
a specified future date. They may arise from sales, financing, or other
transactions. Notes may be short-term or long-term and they require to
pay interest.
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How companies recognize
accounts receivable
ABC Co. on July 1, 2010, sells merchandise on account to Polo
Company for $1,000 terms 2/10, n/30.
On July 10, ABC receives payment from Polo Company for the balance
due.
July 1 Accounts Receivable—Polo Company 1,000
Sales 1,000
July 10 Cash ($900-$18) 882
Sales Discounts ($900 × .02) 18
Accounts Receivable—Polo Company 900
(To record collection of accounts receivable)
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Recognizing Accounts Receivable
Assume that you sale to ABC $300 on account in
merchandise and ABC pay you back on the 30.
Jan. 1- ABC, Accounts Receivable 300
Sales 300
(To record sale of merchandise)
Jan. 30 Cash 300
ABC, Account Receivable 300
(to record received money from ABC)
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The Client Invoice Aging
Client aging reports show unpaid invoices from Accounts Receivable.
These reports show how much clients owe you.
The Client Invoice Aging shows individual unpaid invoices by client.
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Book value vs. Market value
The difference between the cost of any depreciable asset and its related
accumulated depreciation is its book value.
The book value of an asset generally differs from its market value—the
price at which the asset could be sold in the marketplace.
Depreciation is a means of cost allocation, not a market valuation.
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Depreciation
Depreciation is the process of allocating to expense the cost
of a plant asset over its useful (service) life. Cost allocation
enables companies to properly match expenses with revenues
in accordance with the matching principle.
It is important to understand that depreciation is a process of
cost allocation. It is not a process of asset valuation.
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Computing Depreciation
1. Useful life. Useful life is an estimate of the expected productive
life, also called service life, of the asset. Useful life may be expressed in
terms of time, units of activity (such as machine hours), or units of
output. Useful life is an estimate.
2. Salvage value. Salvage value is an estimate of the asset's value at the
end of its useful life. This value may be based on the asset's worth as
scrap or on its expected trade-in value. Like useful life, salvage value is
an estimate.
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Depreciation Methods
Once a company chooses a method, it should apply it consistently over
the useful life of the asset. Consistency enhances the comparability of
financial statements. Depreciation affects the balance sheet through
accumulated depreciation and the income statement through depreciation
expense.
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Straight-line method
Under the straight-line method, companies expense the same amount of
depreciation for each year of the asset's useful life. It is measured solely
by the passage of time.
Depreciable cost is the cost of the asset less its salvage value
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Depreciation and Income Taxes
The Internal Revenue Service (IRS) allows corporate taxpayers to deduct
depreciation expense when they compute taxable income. However, the
IRS does not require the taxpayer to use the same depreciation method
on the tax return that is used in preparing financial statements.
Many corporations use straight-line in their financial statements to
maximize net income. At the same time, they use a special accelerated-
depreciation method on their tax returns to minimize their income taxes.
Taxpayers must use on their tax returns either the straight-line method or
a special accelerated-depreciation method called the Modified
Accelerated Cost Recovery System (MACRS)
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Individual work
Straight-Line Depreciation
On January 1, 2010, AGM Corp. purchased a new snow-grooming
machine for $50,000. The machine is estimated to have a 10-year life
with a $2,000 salvage value. What journal entry would AGM Corp. make
at December 31, 2010, if it uses the straight-line method of depreciation?
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Solution
The entry to record the first year's depreciation would be:
Dec. 31 Depreciation Expense 4,800
Accumulated Depreciation 4,800
(To record annual depreciation on snow-grooming machine)