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Principal Legal Forms of Business. Sole proprietorship. Partnership. Corporation. 80% of businesses, but only 10% of total business revenue. Only 20% of businesses, but 90% of total business revenue. Sole Proprietorship. Simple, inexpensive to setup. Owned by an individual.

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Principal Legal Forms of Business

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principal legal forms of business
Principal Legal Forms of Business
  • Sole proprietorship.
  • Partnership.
  • Corporation.

80% of businesses, but only 10% of total business revenue

Only 20% of businesses, but 90% of total business revenue

sole proprietorship
Sole Proprietorship
  • Simple, inexpensive to setup.
  • Owned by an individual.
  • Not legally separate from the owner.
  • Difficult to raise large amounts of capital.
  • Owner is personally responsible for entity’s debts.
  • Same features as sole proprietorship except owned by two or more partners.
  • Limited partnerships.
    • Managed by general partner who has unlimited liability.
    • Other partners have limited liability.
  • Artificial legal entity (therefore, taxed).
  • Perpetual existence.
  • Legal liability on corporation, not shareholders.
  • Empowered by state.
  • Easiest form to raise capital.
disadvantages of corporation over sole proprietorship or partnership
Disadvantages of Corporation over Sole Proprietorship or Partnership
  • Incorporation costs.
    • Activities limited to those granted in charter.
  • Additional regulations and requirements.
  • Must get permission from each state in which it operates.
  • Double taxation (i.e., corporation is taxed and dividends are taxable income to shareholders).
public vs private corporations
Public vs. Private Corporations
  • Public corporation:
    • Shares traded.
    • Regulated by Securities and Exchange Commission (SEC).
  • Private corporation:
    • Not publicly traded.
    • Usually tightly held (e.g., few individuals, family owned).
proprietorship equity
Proprietorship Equity
  • Capital account.
  • Drawing account (optional).
  • Withdrawals → salary vs. return of profit.
partnership equity
Partnership Equity
  • Separate capital account for each partner.
  • Partnership agreement defines split of profits among partners.
    • May indicate salaries, share of residual profits, % of interest on capital, etc.
    • If not indicated, divided equally.
ownership in a corporation
Ownership in a Corporation
  • Stock certificate.
    • Evidence of ownership.
  • Corporate charter.
    • Filed with state.
    • Indicates classes of stock and maximum number of shares allowed to issue.
  • Owners’ equity.
    • Also called shareholders’ equity or stockholders’ equity.
preferred stock
Preferred Stock
  • Pays stated dividend on face (par) value.
  • Dividend is not tax deductible (as is interest expense paid to creditors).
  • In event of liquidation, are after creditors but before common shareholders.
features of preferred stock
Features of Preferred Stock
  • Cumulative preferred.
    • Current and past dividends (i.e., in arrears) must be paid before common dividends can be paid.
  • Convertible preferred.
    • Convertible into a specified number of common shares.
  • Redeemable preferred.
    • May be redeemed by investor on or after a certain date (price usually higher than par value).
    • Must be shown under liabilities on balance sheet.
common stock
Common Stock
  • Residual interest in net assets after creditors and preferred shareholders.
  • Par or stated value usually a nominal amount (basically meaningless today).
  • Book value of common stock.
    • Total common shareholders’ equity.
      • Paid-in capital.
      • Retained earnings.
shareholders equity
Shareholders’ Equity
  • Paid-in capital.
    • Common stock (at par or stated value).
    • Additional paid-in capital (i.e., proceeds above par value).
  • Retained Earnings.
    • Cumulative net income earned since inception of company (less cumulative total dividends paid).
issuing stock
Issuing Stock
  • Issuance costs.
    • E.g., investment banker, legal, auditing, printing.
    • Reduces Additional paid-in capital amount.
  • Sales after issuance.
    • No effect on company accounts.
    • Corporation notes change of owners.
treasury stock
Treasury Stock
  • Corporation’s own issued stock that has been reacquired.
  • Reasons to reacquire own stock:
    • Needed for acquisitions, bonus plans, exercise of warrants, conversion of bonds/preferred stock.
    • Limited investment opportunities.
    • Increase earnings per share (which can increase market price of stock).
    • Prevent hostile takeover.
accounting for treasury stock
Accounting for Treasury Stock
  • Cost method (simpler method):
    • Debit “Treasury Stock” at acquisition.
      • Not an asset.
      • No voting, no dividends, no shareholder rights.
      • Shown as a reduction of shareholders’ equity.
    • If reissued above cost, increase paid-in capital from treasury stock.
    • If reissued below cost, decrease paid-in capital from treasury stock (if has balance) or retained earnings.
appropriation of retained earnings
Appropriation of Retained Earnings
  • Indicates retained earnings restricted for a specific purpose (thus, not available for dividends).
  • Has no effect on financial position of corporation.
    • Does not reduce total retained earnings.
    • Has no affect on cash.
    • The retained earnings account balance is unrelated to the cash account balance.
cash dividends
Cash Dividends
  • Declaration date.
    • Declared by board of directors.
    • Create liability (i.e., Dividends Payable).
  • Date of record.
    • No entry.
    • Determine who is entitled to dividend.
  • Payment date.
    • Pay out cash, eliminate liability.
stock split
Stock Split
  • Each shareholder receives a multiple of shares previously held (e.g., two-for-one split).
  • No change in total shareholders’ equity (only proportional adjustment to par value).
  • No change in a shareholder’s proportional interest in corporation.
  • Why done? Reduce stock price to make it more appealing to investors.
stock dividends
Stock Dividends
  • Every shareholder receives a percentage of additional shares (e.g., 10% stock dividend).
  • Increases number of shares outstanding, but not proportional interest in corporation.
  • Recorded at market value of shares distributed.
  • If the stock dividend is greater than 20-25%, is basically treated as a stock split.
spin offs
  • Company owns shares of another company (usually a subsidiary) that it distributes to shareholders.
  • Accounting is similar to a cash dividend except reduction is to the Investments asset account (instead of Cash).
  • The right to purchase shares of common stock at a stated price within a given time period.
  • Negotiable (can be bought and sold).
stock options
Stock Options
  • Same as a warrant, but not negotiable.
  • GAAP requires fair value based method.
    • Expense fair value of options over their vesting period.
  • Once vested, option can be exercised even if employee leaves the company.
employee stock ownership plan esop
Employee Stock Ownership Plan (ESOP)
  • A program of setting aside stock for benefit of employees as a group.
  • Contributions to plan are tax deductible to corporation.
  • Plan is a separate entity (thus, assets do not appear on balance sheet, but are disclosed in notes).
earnings per share eps
Earnings Per Share (EPS)
  • Shown on income statement.
  • FASB and IASB requires reporting of:
    • Basic earnings per share (EPS), and
    • Diluted earnings per share (EPS).
basic eps
Basic EPS

Net income available to common shareholders

  • Numerator:
    • Net income – preferred dividends.
  • Denominator:
    • Treasury stock is not considered outstanding.

Basic EPS =

Weighted average number of common shares outstanding

diluted eps
Diluted EPS
  • Basic EPS adjusted for potential dilution.
    • Effects of convertible securities, stock options, stock warrants.
  • Convertible securities: if-converted method.
    • Assume convertible securities were converted to common stock at beginning of year.
  • Stock options/warrants: treasury stock method.
    • Assumes options/warrants are exercised and cash received is used to purchase its stock at the average stock price during the period.
    • Net result with number of shares from exercise of options/warrants.
equity in nonprofit organizations
Equity in Nonprofit Organizations
  • Capital contributions:
    • Endowment.
      • Contributions whose principal is to be kept intact.
      • Earnings on principal are available to finance current operations.
    • Contributed plant.
      • Contributed assets (e.g., buildings) or funds to acquire assets.
  • Operating contributions are revenue, not contributed capital.
  • Operating equity, rather than retained earnings.