If stock is issued by a corporation for less than par; the account Discount-on Capital Stock should be debited for the difference between the issuance price and the par value.
The issuance of stock at a discount is seldom encountered; it is illegal in many states. No-Par Stock Some states allow corporations to issue stock without design,using a par or stated value.
When this “no-par” ‘Stockist issued, the entire issue price is credited to the Capital Stock account and is viewed as legal capital not subject to withdrawal. The account title Capital Stock is widely used when a corporation has issued only one type of stock.
In order to appeal to as many·investors as possible, however, many corporations issue several types (or classes) of capital stock”each providing investors with different rights and opportunities.The basic type of capital stock issued by every corporation often is called common stock.
Common stock possesses the traditional rights of ownership-voting rights, participation in dividends, and a residual claim to assets in the event of liquidation. When any of these rights is modified, the term preferred stock (or sometimes Class B Common) is used to describe the resulting type of capital stock.
A few corporations issue two or more classes of preferred stock, with each class having distinctive features designed to appeal to a particular type of investor.
In summary, we may say that every corporation has common stock and that some corporations also have one or more types of preferred stock. The following stockholders’ equity section illustrates the balance sheet presentation for a corporation having both preferred and common stock:
Characteristics of Preferred Stock
Most preferred stocks have the following distinctive features:
1. Preferred as to dividends
2. Cumulative dividend rights
3. Preferred also assets in event of the liquidation of the company
4. Callable at the option of the corporation
5. No voting power
Another very important but less common feature is a clause permitting the conversion of preferred stock into common at the option of the holder. Preferred stocks vary widely with respect to the special rights and privileges granted. Careful study of the terms of the individual preferred stock contract is a necessary step in the evaluation of any preferred stock.
Stock Preferred as to Dividends we explained that corporations often make periodic cash payments, called dividends, to stockholders Dividends normally represent a distribution of accumulated profit and therefore cannot exceed the amount of a corporation’s retained earnings.
Preferred stock is said to have dividend preference because preferred .stock investors are entitled to receive a specified amount each year before any dividend is paid to common stock investors. The specified dividend may be stated as a dollar amount, such as $5 per share. Some preferred stocks, however, state the specified dividend as we will discuss specific accounting issues related to cash dividends and other forms of distributions to stockholders.
For the purposes of this chapter. dividends may be viewed simply as the distribution to stockholders of accumulated profits that reduce both cash and retained earnings percentage of par value. For example, a share of preferred stock with I par value $100 and a dividend preference of 9% must provide a $9 dividend each year before any dividends are paid on the common shares.
Preferred stocks often leave par values substantially higher than common stocks. is largely a matter of tradition and has little significance.
The holders of preferred stock have no assurance that they will always receive the indicated dividend.
A corporation is obligated to pay dividends to stockholders only when the board of directors declares a dividend. Dividends must be paid on preferred stock before anything is paid to the common stockholders, but if the corporation is not prospering, it may decide not to pay any dividends at all. For a corporation to pay dividends, profits must be earned and cash must be available.
However, preferred stocks generally offer .investors more assurance of regular dividend payments than do common stocks nondisclosure of dividends in arrears.
Cumulative ‘referred Stock The dividend preference carried by most preferred stocks is a cumulative one.
If all or any part of the regular dividend on the preferred stock is omitted in a given year, the amount omitted is said to be in arrears and must paid in a subsequent year before any dividend can be paid on the common stock.
Assume that a corporation was organized January I, 2.000 with .0,000 shares of $8 cumulative preferred stock and 50,000 shares of common stock. Dividends paid in 2000 were at the rate of $8 per share of preferred stock and $2 per share of common.
In 200 J,earnings declined sharply and the only dividend paid was $2 per share on the preferred stock. No dividends were paid in 2002. What is the status of the preferred stock at December 31, 2002? . Dividends are in arrears in the amount of $/4 per share ($6 omitted during 2001 and $8 omitted in 2(02).
On the entire issue of 10,000 shares of preferred stock. the dividends it tears amount to $I4Q.OOO.
Dividends in arrears are not listed among the liabilities of a corporation, because no liability exists until. a dividend is declared. by the board of directors.
Nevertheless, the amount .of any dividends in arrears on preferred stock is an important factor to investors and sho.l4 always be disclosed. This disclosure is usually made by a note accompanying the batten sheet such as the following Note 6:
Dividends. In arrears As of December 31,2002, dividends on the $8 cumulative preferred stock were in arrears to the extent of $14 Per share and amounted in total to $140,000. In 2003, we shall assume that the company earned large. profits and wished to pay dividends on both the preferred and common stocks.
Before paying a dividend on the common, the corporation must pay the $140.000 in arrears on the cumulative preferred slOCk.p/us the regular $8 per share applicable to the current year.
The preferred stockholders would, therefore, receive a total of $220,000 in dividends In 2003 ($22 per share): the. board of di.rectors would then be free to declare dividends on the common stock