I'm Larry Walther, this is principlesofaccounting.com, Chapter 14.
This is the first module in Chapter 14,
and it introduces the corporate form of organization.
Looks at some of the key features of a corporation.
So let's begin by considering that a corporation is a separate legal entity,
separate and apart from its owners or stockholders.
It's created typically when articles of incorporation
are filed with a particular governmental body.
In the United States, that would typically be the Secretary of State in the state in
which the company is formed or incorporated.
Those Articles of Incorporation specify the intent of the corporate entity,
its purpose, its governance structure, and the state will then issue a charter which
authorizes the commencement of the corporation's existence.
Now, once the charter is issued, the shareholders will typically convene in
a preliminary meeting and pool their initial investments, usually at least some
threshold amount of a thousand dollars or so, to breathe life into the company from
a financial point of view, in exchange for shares of stock in the company.
Stock, the shares of stock, is the evidence of ownership in the corporation.
Now at some preliminary meeting of the incorporators they'll adopt bylaws and
elect a board of directors.
The board of directors is essentially the overseeing body that then hires
the officers of the company, who commence with the day-to-day business affairs.
Why would someone form a corporation?
Well, large amounts of capital can be pooled together from many individuals and
concentrated into a single entity.
Something one individual, a sole proprietor,
or maybe just a few people that choose form a partnership could not otherwise do.
Furthermore, the mutual ownership is facilitated through a democratic process.
Typically the common stock of the company, not always but typically is voting, so
that they're able to do things such as elect
the board of directors who hires the officers and so forth.
It gives the ownership a democratic process.
Recognize the shares of stock have transferability.
Typically, there may be some restrictions, but ordinarily,
they're fairly easy transferred.
So stock becomes a liquid asset that's easily transferable.
That's great for an investor who may want to be an investor for
a while, but then be ready to move on and move the money into other things.
The shares may be listed on a public stock exchange.
To do that there would be an initial public offering, for
where a stock is offered to the public for sale for the first time.
That's typically accompanied by the satisfaction of numerous regulatory
requirements, including the appropriation of a perspectives which details
the corporate plan and the intent for
utilization of funds that are raised through the initial public offering.
Another advantage of a corporate form of entity is its perpetual existence.
It essentially lives forever.
It outlives its shareholders.
If shareholders die, the company doesn't die.
The shares are simply transferred to some heir of the deceased, but
the company continues to exist.
Now, when I say it lives for ever and has perpetual existence, obviously,
things do come to a close.
Many corporations will find that they're bought out by other companies and
cease to exist.
They may fail financially.
They may go through some voluntary liquidation.
They decide that it's no longer viable to remain in business, and
they choose to sell the assets and wrap up the affairs of the business.
Another advantage of the corporate form of organization is limited liability.
Stockholders are ordinarily liable only for the amount of their investment.
The debts of the company don't extend to the shareholders.
The creditors are at risk and have a claim only against the assets of the company,
but not against the personal assets of the shareholders.
There's exceptions there.
Shareholders might sign a guarantee of corporate debt,
which case the creditor can attach the assets of the shareholders.
Or shareholders may make a mistake and commingle their personal or
financial affairs or business affairs with those of the corporation.
The court may set aside the corporate entity, it's failed to meet the conditions
necessary to maintain its self as a separate legal entity.
And so they are pitfalls I should say to this idea of limited liability.
But if one's very careful of their legal structure and operating procedures,
it should be possible to preserve that limited liability.
A disadvantage of the corporate form of organization,
at least in the United States, is this idea of Double Taxation.
The corporation is typically a taxable entity, so it pays tax on its income.
The remaining income, when it's distributed to shareholders as dividends,
those dividends ordinarily trigger a taxable event to the shareholder.
So, that can trigger a double taxation effect.
There's relief of available dividends paid from one corporation to another
are eligible for various levels of dividends received deductions.
There are certain corporate form of entities, S-Corporations that can be
formed and structured so that they're not taxable entities, but that the income
flows through to the shareholders and is taxed to the shareholders only one time.
In some countries, they provide for tax holidays in an endeavor to
attract new businesses an corporate investment in their country.
They may say that, for a period of five to ten years,
you won't pay tax on your profit.
Another disadvantage of the corporate form of organization is costly regulation,
particularly for public companies.
There's a lot of regulation to avoid rogue corporations that cheat shareholders out
of their investment money.
The idea is to foster public confidence in the equity markets.
In the United States, there's a Securities and Exchange Commission that heavily
regulates and provides oversight of public companies and their reporting practices.
Those public companies must prepare and file numerous documents.
Oftentimes they are audited and subject to independent verification.
Furthermore, companies are required to maintain strong systems of
internal control.
So there's a number of checks and balances to try to preserve the integrity of
the public corporation as a vehicle that is of interest to potential investors.