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Defining and Understanding the Corporation and Its Accounting

Written by: Wayne Label

Article Overview: Understanding the structure changes and advantages of converting your proprietorship to a corporation is an important step. That knowledge will help you to make the best choices. Find out how your liability, business ownership and remuneration can change once you’ve become a corporation. Take your business to the nest level.

Defining and Understanding the Corporation and Its Accounting

Businesses incorporate for many reasons, not all of them accounting related. Understanding what a corporation is and how it is uniquely run can help you to make this important step in your small business.

Unlike a sole proprietorship, a corporation has the ability to sell shares or stocks to raise capital. The corporation can sell both common and preferred shares. Each has different privileges and opportunities to profit from the company.

Some businesses incorporate strictly to eliminate their personal liability. Creditors can lay claim to the personal assets of a partner or proprietor, but in a corporation the creditors are generally limited to only the assets of the company.

Many businesses incorporate to generate cash for start ups or expansion. In that case, they will issue authorized shares, limited by the number directed in the state charter issued at incorporation. The corporation receives the cash paid and the shareholders own a piece of the company from that point on. When the accounting or fiscal year comes to an end, a corporation may declare dividends and the shareholders will earn money on their investment. In the event that the corporation is liquidated (or ceases operations), the shareholders split the assets based on their percentage owned.

There are a few different types of dividends that a corporation can declare. Cash dividends are paid to holders of both preferred and common shares. Preferred shareholders claim a set amount of dividends and are cumulative - meaning that if the full dividend is not paid in a given year, it becomes arrears and is due to be paid in subsequent years before current dividends can be. Common stock holds no such claim. On the other hand, unless a preferred stock is participating, it cannot claim any of the dividends declared in excess of its minimum. There are advantages and disadvantages to both. Common shares also hold voting rights to elect the board of directors, while preferred usually do not.

Corporations may also choose to issue stock dividends if their cash is unavailable or needed elsewhere. Stock dividends give a shareholder a larger claim in the company. Another option is to issue a stock split, which is often used to attract more investors by lowering the price (splitting the stock). Such interest in the shares will hopefully push the stock price back up, resulting in profit for those who held shares before the split.

In basic terms, a business incorporates to limit liability and generate cash. Its main goals are to make a profit and increase the stock price, satisfying the shareholders desire for return on their investment and allowing them to issue dividends along the way.

To go into further details about the options and advantages in a corporation, study the accounting methods. For simple layouts and explanations, the book "Accounting for Non-Accountants" by Wayne Label is an excellent resource. To get more in depth on this topic, follow Dr. Label's blog on his website or contact him directly athis email. Decide whether incorporation is right for your small business.

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Article Tags: accounting, accounting for nonaccountants, corporation, dividends, incorporate, proprietorship, small business



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