Financial Accounting: An Integrated Statements Approach, 2nd Edition

NATURE OF A CORPORATION

More than 70% of all businesses are proprietorships, and 10% are partnerships. Most

of these businesses are small businesses. The remaining 20% of businesses are corpo-

rations. 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

Corporations have several advantages and disadvantages over proprietorships or part-

nerships as shown in Exhibit 1. A corporation is a separate legal entity that can be used

to raise large amounts of capital that is easily transferable among shareholders, while

limiting the liability of the stockholders to their investment. However, owners are

normally separate from management, are subject to double taxation, and have higher

regulatory costs than other forms of business organization.

494 Chapter 11 Stockholders’ Equity: Capital Stock and Dividends

Describe the nature of

the corporate form

of organization.

1

Advantages Explanation

Separate legal existence A corporation exists separately from its owners.

Continuous life A corporation’s life is separate from its owners; therefore, it exists

indefinitely.

Raising large amounts The corporate form is suited for raising large amounts of money

of capital from shareholders.

Ownership rights easily A corporation sells shares of ownership, called stock. The

transferred stockholders of a public company can transfer their shares of

stock to other stockholders through stock markets, such as the

New York Stock Exchange.

Limited liability 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.

Disadvantages

Owner is separate Stockholders control management through a board of directors.

from management The board of directors should represent shareholder interests;

however, when the board is not sufficiently independent of

management, it is possible for shareholder interests to be poorly

represented.

Double taxation As a separate legal entity, a corporation is subject to taxation.

of dividends Thus, net income distributed as dividends will be taxed once at

the corporation level, and then again at the individual level.

Regulatory costs Corporations must satisfy many regulatory requirements, including

internal control assessments as required by the Sarbanes-Oxley Act

of 2002.^1

Exhibit 1

Advantages and

Disadvantages of the

Corporate Form

1 A Financial Executive International survey estimated the total cost of Sarbanes-Oxley compliance for the

average public company at $3.14 million per year.

Forming a Corporation

The first step in forming a corporation is to file an application of incorporationwith 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. Exhibit 2 lists some corporations that you may be fa-

miliar with, their states of incorporation, and the location of their headquarters.