CHAPTER 13

INTRODUCTION TO CORPORATIONS

Summary of Questions by STUDY Objectives
and Bloom’s Taxonomy

Note: C = Comprehension AN = Analysis AP = Application

Summary of questions by Level of difficulty (lod)

Note: E = Easy M = Medium H=Hard

CHAPTER STUDY OBJECTIVES

1. Identify and discuss characteristics of the corporate form of organization. The major characteristics of a corporation are as follows: separate legal existence, limited liability of shareholders, transferable ownership rights, ability to acquire capital, continuous life, government regulations, and corporate income tax. Corporations must be incorporated federally or provincially, and may have shareholders of different classes. Each class of shares carries different rights and privileges. The rights of common share owners are restricted to the right to elect the board of directors, to receive a proportionate share of dividends, if declared, and to receive the remaining assets if the corporation is liquidated. Corporations are managed by the board of directors.

2. Account for the issuance of common and preferred shares. When shares are issued, the entire proceeds from the issue become legal capital and are credited to the Common Shares account. When shares are issued for noncash assets or services, the fair value of the consideration received is used if it can be determined. If not, the fair value of the consideration given up is used. The accounting for preferred shares is similar to the accounting for common shares.

Preferred shares typically do not have voting rights but do have priority over common shares to receive (1) dividends, and (2) assets, if the company is liquidated. The dividend is specified and may be cumulative or noncumulative. Cumulative preferred shares must be paid dividends for the current year as well as any unpaid dividends from previous years before the common shares many receive dividends. Noncumulative preferred shares lose the right to unpaid dividends from prior years. In addition, preferred shares may be convertible, redeemable, and/or retractable. Convertible preferred shares allow their holder to convert them into common shares at a specified ratio. Redeemable preferred shares give the corporation the right to redeem the shares for cash; retractable give the shareholder the right to convert the shares to cash.

3. Prepare a corporate income statement. Corporate income statements are similar to the income statements for proprietorships and partnerships, with one exception. Income tax expense must be reported in a separate section before profit in the corporation’s income statement.

4. Account for cash dividends. Dividends are similar to drawings in that they are a distribution of profit to the owners (shareholders). Entries for cash dividends are required at the declaration date and the payment date. Cash dividends reduce assets and shareholders’ equity (retained earnings).

5. Prepare a statement of retained earnings and closing entries for a corporation. Retained earnings are increased by profit, and decreased by losses and dividends. Companies reporting under ASPE are required to prepare a statement of retained earnings showing the beginning balance, changes during the year, and ending balance of retained earnings. In a corporation, the income summary account and dividends accounts are closed to retained earnings.

6. Prepare the shareholders’ equity section of the balance sheet and calculate return on equity. Within the shareholders’ equity section of the balance sheet, all corporations will report contributed capital and retained earnings. Within contributed capital, two classifications may be shown if applicable: share capital and additional contributed surplus. Corporations reporting under IFRS will also have another component in shareholders’ equity, which will be introduced in Chapter 14.

Return on equity is calculated by dividing profit by average shareholders’ equity. It is an important measure of a company’s profitability.

Exercises

Exercise 1

The following is a list of characteristics applicable to corporations:

1. Separate legal entity

2. Limited liability of shareholders

3. Transferable ownership rights

4. Ability to acquire capital

5. Continuous life

6. Government regulations

7. Potential for additional tax

8. Potential for deferred or reduced tax

Instructions

For each characteristic determine if it is an Advantage A. or Disadvantage (D) to being incorporated.

Exercise 2

For each of the following statements, indicate whether the statement applies to a proprietorship, a partnership, a private corporation, or a public corporation.

(Select the most likely one by circling your choice).

Exercise 3

Torrie Corporation is authorized to issue an unlimited number of common shares and 1,000,000 shares of preferred shares. During 2013, its first year of operation, the company had profit of $200,000. The following share transactions occurred:

Jan 1 Paid the province $2,000 for incorporation fees.

Jan 15 Issued 500,000 of $1 cumulative preferred shares at $7 per share.

Jan 30 Lawyers for the company accepted 500 common shares as payment for legal services provided in helping the company incorporate. The legal services are estimated to have a value of $5,000. The shares were actively trading at $10.50 per share.

Jul 2 Issued 100,000 common shares for land. The land had an asking price of $900,000. The shares are currently selling on a provincial exchange at $8 per share.

Instructions

a. Journalize the transactions for Torrie Corporation.

b. Prepare the shareholders’ equity section of the balance sheet.

Exercise 4

The following selected transactions pertain to the Liang Corporation:

Jan 3 Issued 100,000 common shares for $25 cash per share.

Feb 10 Issued 6,000 common shares in exchange for special purpose equipment appraised at $159,000. Liang Corporation's common shares have been actively traded on the stock exchange at $27 per share.

Instructions

Journalize the transactions.

Exercise 5

On January 1, 2014, Mandy Merchandise Ltd. has 25,000 common shared issued for a total of $62,500, and no other shares or contributed capital. During 2014, Mandy had the following transactions:

Jan 15 Issued 15,000 common shares for $2.50 each.

Mar 31 Settled an account for legal expenses by issuing 2,500 shares. The value of the legal services was $5,000.

Sep 30 Issued 9,000 shares in exchange for equipment with a fair value of $22,500.

Instructions

a. Record the transactions.

b. Calculate the total number issued and average cost per share of the common shares at the end of 2014.

Exercise 6

During its first year of operations, Millwoods Enterprises Inc. had the following transactions related to its common shares:

Jan 5 Issued 5,000 common shares to Michelle Vogel for $1 each.

Mar 15 Issued 10,000 common shares in exchange for equipment transferred from Vogel. The equipment was valued at $40,000.

Apr 10 Issued 3,500 shares to a consulting firm for management consulting services as settlement of a $14,000 invoice.

Sep 30 Issued 4,000 common shares to Renee Vogel for $5 each.

Instructions

a. Journalize the share transactions.

b. Calculate the average cost of the common shares of Millwoods Enterprises Inc. at December 31.

Exercise 7

The following items were shown on the balance sheet of McKean Corporation on December 31, 2014:

Shareholders’ Equity

Share Capital

Common shares, no par value, unlimited number of shares

authorized; shares issued $1,200,000

$2 preferred shares, redeemable at $120, cumulative,

20,000 shares authorized, 6,000 shares issued 120,000

Total share capital 1,320,000

Retained Earnings 500,000

Total shareholders' equity $1,820,000

Instructions

Complete the following statements and show your calculations. All of the common shares were issued at $5 per share.

a. The number of common shares issued was _______________.

b. The preferred shares dividend was $____________ per share.

c. It would cost the company $____________ to redeem 1,000 preferred shares.

d. The average issue price of the preferred shares was $_____________.

e. The total amount of cash and other assets paid to McKean Corporation in exchange for share capital, at December 31, 2014 was $______________.

Exercise 8

Gabrial Ltd. was incorporated February 1, 2013 and is authorized to issue an unlimited number of preferred and common shares. The company entered into the following transactions during the year:

Feb 10 Issued 30,000 common shares for $23 per share.

Feb 21 Issued 700 common shares to the company’s accountants as payment for a bill of $18,000 for services performed in helping the company to incorporate.

Mar 16 Issued 1,000 convertible preferred shares for $95 per share.

Sep 10 Issued 5,000 convertible preferred shares for $105 per share.

Oct 1 Converted 1,000 preferred shares into common shares. One preferred share is convertible into 10,000 common shares. The fair value of the common and preferred shares are $25 and $102 respectively.

Instructions

Prepare the journal entries to record the above transactions.

Exercise 9

Lake Ltd. was incorporated July 1, 2013. The company is authorized to issue an unlimited number of preferred and common shares. The company entered into the following transactions during its fiscal year ending June 30, 2014:

Jul 10 Issued 100,000 common shares for $12.50 per share.

Jul 15 Issued 400,000 common shares for $13 per share.

Sep 30 Issued 30,000 common shares in return for a warehouse. The common shares were trading for $15.50 on the date the warehouse was acquired. The assessed value of the warehouse on that date was $450,600.

Mar 16 Issued 1,000 preferred shares for $95 per share.

Instructions

Record the above transactions.

Exercise 10

Lee Holdings Ltd. was incorporated on January 2, 2014 and on that date issued 50,000 common shares for cash at $1 each. On April 30, Lee issued 1,000 preferred, $3 cumulative preferred shares, convertible to common shares at the rate of 6 common shares for one preferred share. The preferred shares were issued for $18 each. On October 15, 600 of the preferred shares were converted to common shares. On that date, the market value was $1.50 for the common shares and $17.50 for the preferred shares.

Instructions

Journalize the share transactions described.

Exercise 11

Sonoma Lakes Ltd. (SLL) has the following authorized share capital:

Unlimited Common voting shares

500,000 Class A, $5 cumulative preferred shares

500,000 Class B, $10 non-cumulative preferred shares

During 2014, SLL had the following share transactions for cash:

Jan 1 Issued 50,000 common shares for $100,000.

Mar 12 Issued 1,000 Class A preferred shares for $60,000.

Apr 30 Issued 20,000 common shares for $2.50 per share.

Jun 20 Issued 3,000 Class B preferred shares for $70 per share.

SLL did not declare any dividends during 2014. On December 31, 2015 a dividend of $3 per share was declared on preferred shares issued.

Instructions

a. Journalize the share transactions.

b. Calculate the number of common shares issued at December 31, 2014.

c. Calculate the amount of the December 31, 2015 total dividend declared and the amount of dividends in arrears after declaring the December 31, 2015 dividend.

Exercise 12

The Adams Corporation issued 1,000, no par value, convertible preferred shares at $100 per share. Each share is convertible into 10 common shares. When the market values of the two classes of shares are $101 and $13, respectively, 150 preferred shares are converted into common shares.

Instructions

a. Journalize the conversion of the 150 shares.

b. Repeat a. assuming that the market values at conversion are $103 and $20, respectively.

Exercise 13

Kis Corp. declared $35,000 in dividends in 2014. Share capital consists of 1,100 common shares and 3,700, $2 preferred shares. Dividends have not been paid on the preferred shares since 2011.

Instructions

Determine the dividends to be paid on preferred shares assuming:

a. the preferred shares are cumulative.

b. the preferred shares are non-cumulative.

Exercise 14

Hunter Corporation is authorized to issue 2,000,000, common shares. During its first three years of operation, Hunter issued 1,200,000 shares at $15 per share. In 2013, Hunter issued an additional 5,000 shares in return for equipment with a fair value of $75,000. The market price of the shares was $16 at the time of the sale.

Instructions

Based on the above information, answer the following questions:

a. How many shares are authorized at the end of 2013?

b. How many shares are issued at the end of 2013?

c. What is the value of the Common Shares account at the end of 2013?

Exercise 15

In its first year of operations, Arnold Corporation had the following transactions relating to its convertible preferred shares and common shares. The preferred dividend rate is $2 per share.

Jan 1 Issued 10,000 common shares at $10 per share.

Feb 1 Issued 3,000 preferred shares for $41 per share.

Jul 1 Declared and paid annual preferred dividends.

Nov 1 Converted 1,000 preferred shares to common shares when the market value of the preferred shares was $42 and the market value of the common shares was $20. One share of preferred is convertible to 10 common shares.

Instructions

a. Journalize the transactions.

b. Indicate the amount to be reported for (1) preferred shares and (2) common shares at the end of the year.

Exercise 16

Moreland Holdings Inc. has authorized share capital of an unlimited number of common shares and 1,000,000 preferred, $3-cumulative preferred shares. At January 1, 2014, the balances in its share capital accounts were $45,000 in common shares representing 15,000 shares and $30,000 in preferred shares representing 1,000 shares. The retained earnings balance on that date was $180,000. Profit for the year ending December 31, 2014 was $24,000. There were no dividends in arrears at January 1, 2014 and no dividends were declared during 2014.

During 2014, Moreland had the following share transactions:

Mar 1 Issued 4,000 common shares for $5 each.

Jun 30 Issued 500 preferred shares for $11 each.

Sep 1 Issued 60,000 common shares in exchange for land valued at $285,000.

Instructions

a. Journalize the share transactions.

b. Prepare the equity section of Moreland’s balance sheet at December 31, 2014 and describe any additional disclosure required related to share capital.

c. Calculate return on equity for 2014.

Exercise 17

RD Holdings Ltd. which has authorized share capital of an unlimited number of common shares, and 1,000,000 preferred shares, had the following share transactions during 2014, its first year of operations:

Jan 2 Issued 30,000 common shares at $0.10 each.

Jan 5 Issued 50,000 common shares to Roy Daines in exchange for management services valued at $5,000.

Jan. 31 Issued 1,000,000 common shares to Rachel Daines in exchange for merchandise inventory valued at $15,000, land valued at $30,000 and a building valued at $55,000.

Mar 31 Issued 60,000 to Gilmore Law Firm in exchange for legal services. It is assumed that the market price of RD Holding’s shares is unchanged since January 2.

Dec 1 Issued 20,000 of $2 preferred shares for $20 per share.

Instructions

a. Record the 2014 share transactions.

b. Prepare the share capital section of RD Holdings' balance sheet at December 31, 2014.

Exercise 18

Pearl Holdings Inc. was incorporated on July 1, 2014 with authorized share capital of 1,000,000 common shares and 500,000 preferred $4-cumulative preferred shares, convertible to common shares at a rate of 10 common shares for each preferred share. During its first year of operations, Pearl had profit of $126,000, and declared no dividends. Pearl had the following transactions related to share capital during the year:

Jul 1 2014 Issued 100,000 common shares for $2 each.

Jul 1 2014 Issued 5,000 preferred shares for $75 each.

Aug 15 2014 Issued 10,000 common shares for legal services received, valued at $25,000.

Dec 1 2014 Issued 5,000 common shares at $2.25 each in exchange for equipment received.

Mar 8 2015 Half of the preferred shares were converted to common shares. On this date, the market value of the common shares was $3.10 and the preferred share value was $80.

Instructions

a. Prepare the entries to record the share transactions described above.

b. Prepare the shareholder equity section of Pearl’s balance sheet at June 30, 2015, the date of its first year end.

c. Calculate the return on equity for the first year of operations. Use the July 1, 2014 share capital as the beginning balance for the purpose of calculating average shareholder equity.

Exercise 19

The following information is available from the accounting records of DeWitt Engineering Ltd. for the year ended June 30, 2014:

Fee discounts and allowances $ 26,000

Fee revenue 1,560,000

Interest revenue 6,000

Other operating expenses 590,000

Salaries expense 750,000

Instructions

Prepare a corporate Income Statement for the year ended June 30, 2014. The company has a 30% income tax rate.

Exercise 20

At December 31, 2015, Estania Corporation reports revenue of $5,750,000 and expenses of $3,920,000. The company has a tax rate of 27%. During the year, the company declared and paid dividends of $650,000.

Instructions

Prepare an income statement and record the adjustment to income taxes assuming no taxes have yet been accrued.

Exercise 21

For the year ended August 31, 2016, Zen Fitness Inc. had service revenue of $625,000; operating expenses of $265,000 and other expenses of $32,000. The company has a 20% tax rate and has previously accrued $25,000 in income taxes.

Instructions

a. Determine the income tax expense.

b. Prepare an income statement.

c. Prepare the entry to record the income taxes.

Exercise 22

Below is a list of income statement accounts for Debui Inc. as of December 31, 2014:

Revenue $5,960,000

Income tax Expense 875,625

Income tax payable 750,000

Profit 2,626,875

Other expenses 97,500

Salaries Expense 850,000

Supplies Expense 410,000

Interest Expense 1,100,000

Instructions

a. Present the income statement in the correct order.

b. What is the applicable tax rate for Debui Inc.?

Exercise 23

Mayer corporation, a private company reporting under ASPE has the following information available with respect to the company’s operations until December 31, 2016:

1. Collected $345,000 cash for service revenue earned.

2. Paid $125,000 salaries expense, $56,000 rent expense, and $5,000 insurance expense.

3. Purchased a new vehicle for $35,000 cash on January 1, 2016. This vehicle will be depreciated over 5 years with no salvage value.

4. Accrued $16,000 for income taxes during 2016.

5. On December 31. 2016 the following adjustments were completed:

Service revenue earned but not yet collected in cash $22,500

Accrued Interest expense $4,500

Accrued Salaries expense $7,200

Mayer has a 20% income tax rate.

Instructions

Prepare an income statement and record the adjustment to income taxes.

Exercise 24

The trial balance of Terris Inc. for the year ended September 30, 2014, prior to recording of tax expenses, but after all other adjustments, is as follows. All accounts are their normal balance (debit or credit). Terris has a tax rate of 30%.

Accounts payable $ 80,000

Accounts receivable 40,000

Cash 50,000

Cash dividends 7,000

Common shares 30,000

Cost of goods sold 175,000

Dividends payable 4,000

Interest expense 4,500

Inventory 120,000

Operating expenses 92,300

Preferred shares 25,000

Retained earnings, beginning balance 11,900

Sales revenue 320,000

Taxes payable 100

Instructions

Prepare the income statement and statement of retained earnings for Terris Inc. for the year ended September 30, 2014.

Exercise 25

The following information is taken from the trial balance of GlaxonSmith Supplies Ltd. at December 31, 2014, the company’s year end. GlaxonSmith has a 15% tax rate.

Cash dividends $ 7,500

Common shares 9,000

Cost of goods sold 65,000

Dividends payable 2,500

Interest revenue 300

Operating expenses 16,900

Preferred shares 10,000

Retained earnings, beginning balance 3,100

Sales revenue 90,000

Instructions

Prepare the income statement and statement of retained earnings for GlaxonSmith for the year ended December 31, 2014.

Exercise 26

Yaya Blossom’s Inc. has a March 31, 2014 fiscal year end and a 35% income tax rate. The following information is available for its 2014 year end:

1. Performed $880,000 service revenue and paid $325,000 in salaries. Interest expense was $12,600.

2. Paid dividends in December 2013 of $14,000 that had been declared in November 2013.

3. On March 10, 2014 declared dividends of $19,000 payable April 30, 2014.

4. Recorded and remitted taxes of $140,000 (related to 2014 fiscal year) during the year.

5. Issued common shares for $15,000 on January 31, 2014.

6. Retained earnings balance on April 1, 2013 is $67,000.

Instructions

a. Prepare an income statement and record the adjustment to income tax.

b. Prepare a statement of retained earnings.

Exercise 27

Maki and Levesque Inc. has recorded all necessary adjusting entries, except for income tax expense, at its fiscal year end August 31, 2016. The following information has been taken from the adjusted trial balance:

Cash 119,000

Inventory 122,000

Sales 960,000

Interest Expense 35,000

Notes Payable 126,000

Unearned Revenue 33,000

Retained Earnings (September 1, 2015) 6,325

Salaries Expense 110,000

Supplies Expense 25,000

Accounts Payable 45,000

Income tax Payable 6,175

Common shares 91,000

Accounts receivable 122,000

Cost of goods sold 722,000

Insurance expenses 12,500

$1,267,500 $1,267,500

Maki and Levesque Inc. has a 15% tax rate.

Instructions

a. Prepare a multi step income statement and the required journal entry to adjust income tax expense.

b. Prepare a statement of retained earnings.

c. Prepare closing entries.

Exercise 28

Austrian Limited is a private corporation reporting under ASPE. At December 31, 2015, its general ledger contained the following summary data:

Sales $1,200,000

Interest expense 16,000

Operating expenses 275,000

Cost of goods sold 625,000

Retained earnings January 1, 2015 497,000

Additional information:

1. In 2015 dividends of $35,000 were declared on July 1 and December 31 respectively. The dividends were paid on August 10, 2015 and January 15, 2016 respectively.

2. The company’s tax rate is 33%.

Instructions

a. Determine the income tax expense and prepare a multi step income statement for 2015.

b. Prepare a statement of retained earnings for 2015.

Exercise 29

KBR Investments Inc. has issued 90,000 Class A $3 cumulative preferred shares and 45,000 Class B $5 non-cumulative preferred shares. At the end of 2012, there were no dividends in arrears. During 2013, KBR paid dividends of $100,000 to its Class A shareholders. In January of 2014, KBR paid dividends of $120,000 to its Class A shareholders. On December 31, 2014, KBR declared dividends in an amount sufficient to pay out all of the remaining dividends in arrears plus the entire current year obligation including dividends on Class B shares, so that they can pay dividends on common shares.

Instructions

Calculate the dividends declared for Class A and for Class B shareholders on December 31, 2014.

Exercise 30

Trainor Corporation was organized on January 1, 2014. During its first year, the corporation issued 20,000 preferred shares with a $0.30 dividend entitlement and 200,000 common shares, both at $1 per share. At December 31, the corporation’s year end, Trainor declared the following cash dividends:

Preferred shares Common Shares

2014 $0.25 per share $0.00

2015 as required by terms $0.05 per share

2016 as required by terms $0.15 per share

Instructions

a. Calculate the total dividends and the amount paid to each class of shares, assuming the preferred dividend is not cumulative.

b. Calculate the total dividends and the amount paid to each class of shares, assuming the preferred dividend is cumulative.

c. Journalize the declaration of the cash dividend at December 31, 2015 using the assumption of part b.

Exercise 31

On January 1, 2014, Hobbs Corporation had 60,000 common shares issued at $1 per share. During the year, the following transactions occurred:

Mar 1 Issued 40,000 common shares for $600,000.

Jun 1 Declared a cash dividend of $2 per share to shareholders of record on June 15.

Jun 30 Paid the $2 cash dividend.

Profit for 2014 amounted to $651,000.

Instructions

Prepare journal entries to record the above transactions.

Exercise 32

The shareholders' equity section of Karr Corporation at December 31, 2013 included the following:

$6 preferred shares, cumulative,

10,000 shares authorized, 8,000 shares issued $ 800,000

Common shares, 250,000 shares authorized,

200,000 shares issued $2,000,000

Dividends were not declared on the preferred shares in 2013 and are in arrears.

On September 15, 2014, the board of directors of Karr Corporation declared dividends on the preferred shares for 2013 and 2014, to shareholders of record on October 1, 2014, payable on October 15, 2014.

On November 1, 2014, the board of directors declared a $2 per share dividend on the common shares, payable November 30, 2014, to shareholders of record on November 15, 2014.

Instructions

Prepare the journal entries that should be made by Karr Corporation in 2014 on the dates indicated below:

September 15 November 1

October 1 November 15

October 15 November 30

Exercise 33

At December 31, 2013, Cabot Corporation reports revenue of $3,500,000 and expenses of $2,300,000. During the year, the company declared and paid dividends of $400,000. The company had $1,500,000 in retained earnings at the beginning of 2013.

Instructions

a. Prepare the closing entries for 2013.

b. Prepare a statement of retained earnings for December 31, 2013.

Exercise 34

Burbon Ltd. is a private company reporting under ASPE. The adjusted trial balance at its fiscal year end, December 31, 2016, is shown below:

BURBON LTD.

Adjusted Trial Balance

December 31, 2016

Debit Credit

Cash 25,000

Accounts Receivable 16,000

Inventory 333,000

Prepaid Expenses 24,000

Supplies 1,600

Equipment 37,500

Accounts Payable 36,000

Income tax payable 72,000

Unearned Revenue 86,000

Common shares (56,000 issued) 56,000

Retained Earnings (January 1, 2016) 19,900

Dividends 5,600

Sales 772,000

Cost of goods sold 445,000

Depreciation expense 7500

Interest expense 1,000

Wages expense 72,000

Insurance expense 1,100

Income tax expense 57,600

Rent expense 15,000

$1,041,900 $1,041,900

Instructions

a. Prepare a statement of retained earnings.

b. Journalize the closing entries.

Exercise 35

Byrne Corporation had the following accounts at January 1, 2014:

common shares, unlimited number of shares authorized, 7,000 shares issued, $197,000;

preferred shares, $9.50 cumulative, unlimited number of shares authorized, 2,000 shares issued, $63,500;

retained earnings, $263,000.

During the year, the company paid the preferred dividend and paid a $1.50 dividend to the common shareholders. The company had profit of $333,000.

Instructions

Prepare the shareholders’ equity section of the balance sheet at December 31, 2014.

Exercise 36

Nicco Corporation had the following accounts at January 1, 2013:

common shares, unlimited number of shares authorized, 18,000 shares issued, $180,000;

preferred shares, $4 cumulative, unlimited number of shares authorized, 1,000 shares issued, $50,000;

retained earnings, $223,000.

The company has profit of $79,000 in 2013 and paid $85,000 in dividends.

Instructions

a. Calculate the return on equity at December 31, 2013.

b. What does this ratio tell you about the corporation?

Exercise 37

Cordoza Corporation had profit of $400,000 in 2014. Total shareholders’ equity was $1,400,000 at December 31, 2012; $1,500,000 at December 31, 2013; and $1,600,000 at December 31, 2014.

Instructions

Calculate return on equity for 2014 and explain what it means.