ACC 202 - Corporation formation quiz

Read the following article on Corporation Formation, then make the required journal entry, and show the status of the balance sheet.

A corporation is created at the state level, so there needs to be approval by the state as to the nature and activities of the corporation.  Upon approval, the company will be authorized to issue some maximum number of shares to the public.  The corporation may decide to issue all of its shares at once, or to issue some shares now and some shares later.  Similar to the situation for a proprietorship or partnership, the issuance of stock brings in cash, and also establishes the ownership of the corporation. We call the owner's equity for the corporation "shareholders' equity" or "stockholders' equity."

An Example of Issuing Stock

Walter Corporation is incorporated in the state of Washington, and has been granted an authorization to issue 100,000 shares of its $1.00 par common stock.  In January, Walter actually issued 9,000 shares of the common stock and received $4.00 per share for it.  This transaction would be journalized as follows:

The par value is a dollar amount that is printed on the face of the stock certificate.  It represents the minimum price for one share of stock.  In the example above, the state would expect that each share sold to investors would be sold for at least $1.00 per share.  It would be okay if the share was sold for $1.00, or $3.00 or $10.00, but not for $.50 or $.75.  In the case where the shares are issued for more than par, we credit the Common Stock account for the par amount, and the additional amount is placed in an account called Paid in Capital in Excess of Par.

It might seem that the corporation is making a profit in selling these shares, but we don't consider the extra amount to be net income.  This is because net income is earned from selling a product or service, not from a company selling its own stock.

A Balance Sheet

After recording and posting the transaction shown above, we can construct a balance sheet.  As you know, the balance sheet formula is Assets = Liabilities + Owner's Equity.  For a corporation, the formula becomes Assets = Liabilities + Stockholders' Equity.

What would you find in the Stockholders' Equity section?  You would find two main sections:  the Paid in Capital Section, and the Retained Earnings section.  Paid in Capital represents the amounts that investors have invested in the business; Retained Earnings represents the amount earned by the corporation and kept in the business.

A balance sheet for Walter Corporation would appear as follows: