Chapter 11, Problem 1STQ

To determine

Identify the statement which is true about a corporation form of business.

Answer to Problem 1STQ

b. Fluctuations in the market value of outstanding shares of capital stock do not directly affect the amount of stockholders’ equity shown in the balance sheet.

Explanation of Solution

Corporation: A business concern where there is a separate legal entity, and are owned by shareholders, are known as corporation. Transfer of ownership and raising funds are easy in this form of organization. The liabilities of the stockholders to its creditors are limited up to their invested capital amount in the corporation.

Justification for incorrect options:

a.

Shareholders’ are not personally liable for the business debt. The liability of a corporation is limited, which means that the liability of stockholders is limited only to the extent of their investment amount. This is because a corporation is a separate legal entity. Thus, the corporation is liable to settle all its debts and obligations from the assets available in the corporation.

c.

A corporation is entitled to double taxation. The corporation is required to pay the taxes based on its net income. In addition, dividends that are distributed to the shareholders are also taxable in the hands of stockholders.

Thus, shareholders have to pay tax personally on the dividend income received from their investment.

d.

Shareholders are the owners of a corporation, but they elect board of directors to administer the business. Board of directors appoints professional managers to run the business.

As the ownership and management is separate in a corporation, corporation form of business prevents the stockholders to play an active role in management functions of a business corporation.

Thus, the shareholders’ do not have any right to make managerial decisions and bind the corporation to contracts.

Justification for correct option:

b.

The stockholders’ equity section of the balance sheet will not be affected, due to fluctuations in trading price of outstanding shares of capital stock. Because, the capital stocks are recorded based on the market share price on the date in which the shares were originally issued. Hence, fluctuations in trading price of outstanding shares of capital stock will not affect the stockholders’ equity section.