Accounting: The Language of Business (Part 73)

Corporation: An ingenious device for obtaining profit without individual responsibility.

Ambrose Bierce

Corporations: Organization, Capital Stock Transactions, and Dividends (Part A)

by

Charles Lamson

If you own stock in a corporation, you are interested in how the stock is doing in the market. If you are considering buying stocks, you are interested in your rights as a stockholder and returns that you can expect from the stock.

Although you may not own any stocks, you probably buy services or products from corporations, and you may work for a corporation. Understanding the corporate form of organization will help you in your role as a stockholder, a consumer, or an employee. In the next several posts, we discuss the characteristics of corporations, as well as how corporations account for stocks.

Nature of a Corporation

In the preceding posts, we used the proprietorship in illustrations. According to Census data, 73.1% of businesses are sole proprietorships and 8% are partnerships (taxfoundation.org). Most of these businesses are small businesses. The remaining 18.9% of businesses are corporations. Many corporations are large and, as a result, they generate more than 90% of the total business dollars in the United States.

Characteristics of a Corporation

A corporation is a legal entity, distinct and separate from the individuals who create and operate it. As a legal entity, a corporation may acquire, own, and dispose of property in its own name. It may also incur liabilities to enter into contracts. Most importantly, it can sell shares of ownership, called stock. This characteristic gives corporations the ability to raise large amounts of capital.

The stockholders or shareholders who own the stock own the corporation. They can buy and sell stock without affecting the corporation's operations or continued existence. Corporations whose shares of stock are traded in public markets are called public corporations. Corporations whose shares are not traded publicly are usually owned by a small group of investors and are called nonpublic or private corporations.

The stockholders of a corporation have limited liability. This means that a corporation's creditors usually may not go beyond the assets of the corporation to satisfy their claims. Thus, the financial loss that a stockholder may suffer is limited to the amount invested. This feature has contributed to the rapid growth of the corporate form of business.

The stockholders control a corporation by electing a board of directors. This board meets periodically to establish corporate policies. It also selects the chief executive officer (CEO) and other major officers to manage the corporation's day-to-day affairs. Exhibit 1 shows the organizational structure of a corporation.

EXHIBIT 1 Organizational Structure of a Corporation

As a separate entity, a corporation is subject to taxes. For example, corporations must pay federal income taxes on their income. Thus, corporate income that is distributed to stockholders in the form of dividends has already been taxed. In turn, stockholders must pay income taxes on the dividends they receive. This double taxation of corporate earnings is a major disadvantage of the corporate form.

Forming a Corporation

The first step in forming a corporation is to file an application of incorporation with the state. State incorporation laws differ, and corporations often organize in those states with the more favorable laws. For this reason, more than half of the largest companies are incorporated in Delaware.

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After the application of incorporation has been approved, the state grants a charter or articles of incorporation. The articles of incorporation formally create the corporation. The corporate management and board of directors then prepare a set of bylaws, which are the rules and procedures for conducting the corporation's affairs.

Costs may be incurred in organizing a corporation. These costs include legal fees, taxes, state incorporation fees, license fees, and promotional costs. Such costs are debited to an expense account entitled Organizational Expenses. To illustrate, the journal entry (see part 10) of a corporation's organizing costs of $8,500 on January 5 is shown below. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 482-484*

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