CH 14

Download as ppt, pdf, or txt
Download as ppt, pdf, or txt
You are on page 1of 51

Chapter 14

Corporations:
Dividends, Retained
Earnings, and Income
Reporting
Chapter
14-1
Study
Study Objectives
Objectives

1. Prepare the entries for cash dividends and stock


dividends.
2. Identify the items reported in a retained
earnings statement.
3. Prepare and analyze a comprehensive
stockholders’ equity section.
4. Describe the form and content of corporation
income statements.
5. Compute earnings per share.

Chapter
14-2
Corporations:
Corporations: Dividends,
Dividends, Retained
Retained
Earnings,
Earnings, and
and Income
Income Reporting
Reporting

Statement
Retained
Dividends Presentation and
Earnings
Analysis

Cash dividends Retained earnings Stockholders’


Stock dividends restrictions Equity Presentation
Stock splits Prior period Stockholders’
adjustments Equity Analysis
Retained earnings Income Statement
statement Presentation
Income Statement
Analysis

Chapter
14-3
Dividends
Dividends

A distribution of cash or stock to stockholders


on a pro rata (proportional) basis.

Types of Dividends:
1. Cash dividends. 3. Stock dividends.
2. Property
dividends.
Dividends expressed: (1) as a percentage of the par
or stated value, or (2) as a dollar amount per share.

Chapter
14-4 SO 1 Prepare the entries for cash dividends and stock
Dividends
Dividends

Cash Dividends
For a corporation to pay a cash dividend, it must
have:

1. Retained earnings - Payment of cash


dividends from retained earnings is legal in all
states.

2. Adequate cash.

3. A declaration of dividends by the Board of


Directors.
Chapter
14-5 SO 1 Prepare the entries for cash dividends and stock
ENTRIES
ENTRIES FOR
FOR CASH
CASH DIVIDENDS
DIVIDENDS
Dividends require information concerning three dates:

the declaration date, (2) the record date, and (3) the payment date.

Normally, there are two to four weeks between each date

.On the declaration date, the board of directors formally declares the
cash dividend and announces it to stockholders. Declaration of a cash
dividend commits the corporation to a legal obligation. The company
makes an entry to recognize the decrease in retained earnings and the
increase in the liability Dividends Payable.

The record date The purpose of the record date is to identify the
persons or entities that will receive the dividends, not to determine the
amount
Chapter
of the dividends liability
14-6
Chapter
14-7
Dividends
Dividends

Illustration: On Dec. 1, the directors of Media General declare a 50¢


per share cash dividend on 100,000 shares of $10 par value common
stock. The dividend is payable on Jan. 20 to shareholders of record on
Dec. 22?
December 1 (Declaration Date) The dividend is $50,000 (100,000
x 50¢)
Retained earnings 50,000
Dividends payable 50,000

Dividends Payable is a current liability: it will normally be paid within


the next several months

December 22 (Date of Record) No entry is required on this date

Chapter
14-8
January 20 (Payment Date)
On the payment date, the company mails dividend checks to the
stockholders and records the payment of the dividend. Assuming that the
payment date is January 20 for Media General, the entry on that date is:

Dividends payable 50,000


Cash 50,000

ABC, Inc. has 1,000 shares of 4%, $100 par value,


cumulative preferred stock and 50,000 shares of $1 par
value common stock outstanding at December 31,
2008. What is the
annual dividend on the preferred stock?

Chapter
14-9
Dividends
Dividends

Allocating Cash Dividends Between


Preferred and Common Stock
preferred stock has priority over common stock
in regard to dividends.
cumulative preferred stock: must be paid
any unpaid prior-year dividends and its
current year’s dividend before common
stockholders receive dividends.
In contrast, non-cumulative preferred
stocks do not have this feature and offer
Chapter
companies greater financial flexibility as they
14-10
are not obligated to pay missed dividends
Dividends
Dividends
Illustration. Assume that at December 31, 2010, IBR Inc. has 1,000
shares of 8%, $100 par value cumulative preferred stock. It also has
50,000 shares of $10 par value common stock outstanding. The dividend
per share for preferred stock is $8 ($100 par value 8%). The required
annual dividend for preferred stock is therefore $8,000 (1,000x $8).
At December 31, 2010, the directors declare a $6,000 cash dividend.
In this case, the entire dividend amount goes to preferred stockholder
because of their dividend preference.

The entry to record the declaration of the dividend is:


Retained earnings 6,000
Dividends payable
Chapter
14-11 (To record $6 per share cash dividend to preferred stockholders)
Because of the cumulative feature, dividends of $2 per share are in
arrears on preferred stock for 2010. The company must pay these
dividends to preferred stockholders before it can pay any future
dividends to common stockholders.
IBR should disclose dividends in arrears in the financial statements. At
December 31, 2011, IBR declares a $50,000 cash dividend.
The allocation of the dividend to the two classes of stock is as
follows

Allocating dividends to preferred and common stock

Chapter
14-12
The entry to record the declaration of the dividend
is:

Retained earnings 50,000


Dividends payable
(To record declaration of cash
50,000
dividends of $10,000 to preferred stock
and $40,000 to common stock)
Agler, Inc. has 10,000 shares of 6%, $100 par
value, cumulative preferred stock and
100,000 shares of $1 par value common stock
outstanding at December 31, 2008. If the
board of directors declares a $50,000 dividend,
the
preferred shareholders will receive?
Chapter
14-13
NOTE:
✔ Determine dividends on preferred shares by multiplying the dividend
rate times the par value of the stock times the number of preferred shares.
✔ Understand the cumulative feature: If preferred stock is cumulative,
then any missed dividends (dividends in arrears) and the current year’s
dividend must be paid to preferred stockholders before dividends are paid
toChapter
common stockholders
14-14
Chapter
14-15
Manner, Inc. has 5,000 shares of 6%, $100 par value,
noncumulative preferred stock and
20,000 shares of $1 par value common stock
outstanding at December 31, 2008. There
were no dividends declared in 2007. The board of
directors declares and pays a $55,000
dividend in 2008. What is the amount of dividends
received by the common stockholders
in 2008?

Chapter
14-16
Stock
Stock Dividends
Dividends
 When a company issues a stock dividends, it rewards
shareholders with additional shares of stock for each share they
already own rather than paying them in cash. The amount of stock
dividends paid out depends on the number of shares an investor owns,
where one dividend equals a fraction of a share.
 For instance, an investor who owns 100 shares receives a total of 10
additional shares if the issuing company distributes a 10% stock
dividend. A stock dividend results in an issuance equal to or less
than 25% of outstanding shares.
 When a company issues a stock dividend, an amount equivalent to the
value of the issued shares is deducted from retained earnings and
capitalized to the paid-in capital account.

Chapter
14-17
Dividends
Dividends

Stock Dividends
Reasons why corporations issue stock dividends:
1. To satisfy stockholders’ dividend expectations
without spending cash.
2. To increase the marketability of the corporation’s
stock.
3. To emphasize that a portion of stockholders’
equity has been permanently reinvested in the
business.

Chapter
14-18
Dividends
Dividends

Size of Stock Dividends

Small stock dividend (less than 20–25% of


the corporation’s issued stock, recorded at fair
market value)*

Large stock dividend (greater than 20–25%


of issued stock, recorded at par value)

* This accounting is based on the assumption that a


small stock dividend will have little effect on the market
price of the outstanding shares.
Chapter
14-19 SO 1 Prepare the entries for cash dividends and stock
To illustrate the accounting for small stock dividends,
assume that Medland Corporation has a balance of $300,000 in retained
earnings. It declares a 10% stock dividend on its 50,000 shares of $10 par
value common stock. The current fair market value of its stock is $15 per
share.

The number of shares to be issued is 5,000 (10% x 50,000). Therefore the


total amount to be debited to Retained Earnings is $75,000 (5,000 x$15).

The entry to record the declaration of the stock dividend is as follows:

Retained Earnings 75,000


Common Stock Dividends Distributable 50,000 (10 x 5,000)
Paid-in Capital in Excess of Par Value 25,000 (15-10 =5 x5,000)

(To record declaration of 10% stock dividend)


Chapter
14-20
Medland debits Retained Earnings for the fair market value of the stock
issued ($15 x 5,000). It credits Common Stock Dividends Distributable
for the par value of the dividend shares ($10 x 5,000), and credits Paid-in
Capital in Excess of Par Value for the excess over par ($5x 5,000)
Common Stock Dividends Distributable is a stockholders’ equity
account.

When Medland issues the dividend shares, it debits Common Stock


Dividends Distributable, and credits Common Stock, as follows.
Common Stock Dividends Distributable 50,000
Common Stock 50,000
(To record issuance of 5,000 shares in a stock dividend)
Chapter
14-21
rving Corporation's stockholders' equity section at
December 31, 2007 appears below:
Stockholders' equity
Paid-in capital
Common stock, $10 par, 60,000 outstanding
$600,000
Paid-in capital in excess of par
150,000
Total paid-in capital
$750,000
On June 30,
Retained 2008, the board of directors of Irving
earnings
Corporation
150,000 declared a 15% stock dividend, payable
on
TotalJulystockholders'
31, 2008, to stockholders
equity of record on July
15, 2008. The fair market value of
$900,00
Irving Corporation's stock on June 30, 2008, was
$15.
Prepare the journal entries on the appropriate
Chapter
dates to record the stock dividend
14-22
Chapter
14-23
Dividends
Dividends

Question
Which of the following statements about small
stock dividends is true?
a. A debit to Retained Earnings for the par value
of the shares issued should be made.
b. A small stock dividend decreases total
stockholders’ equity.
c. Market value per share should be assigned to
the dividend shares.
d. A small stock dividend ordinarily will have no
effect on book value per share of stock.
Chapter
14-24 SO 1 Prepare the entries for cash dividends and stock
Dividends
Dividends

Question
In the stockholders’ equity section, Common
Stock Dividends Distributable is reported as a(n):
a. deduction from total paid-in capital and
retained earnings.
b. current liability.
c. deduction from retained earnings.
d. addition to capital stock.

Chapter
14-25 SO 1 Prepare the entries for cash dividends and stock
EFFECTS OF STOCK DIVIDENDS
How do stock dividends affect stockholders’ equity? They change the
composition of stockholders’ equity, because they transfer to paid-in
capital a portion of retained earnings. . However, total stockholders’ equity
remains the same

In this example, total paid-in capital increases by $75,000, and


retained earnings decreases by the same amount. Note also that total
Chapter
14-26
stockholders’ equity remains unchanged at $800,000.
Sing CD Company has had five years of record earnings. Due to this
success, the market price of its 500,000 shares of $2 par value common
stock has tripled from $15 per share to $45. During this period, paid-in
capital remained the same at $2,000,000. Retained earnings increased
from $1,500,000 to $10,000,000.
CEO Joan Elbert is considering a 10% stock dividend.

The entry to record the declaration of the stock dividend is?


The entry to record the issuance of the dividend shares?
show the before-and-after effects on (a) retained earnings and (b)
total stockholders’ equity
The stock dividend amount is $2,250,000 [(500,000 x 10%) $45]. The
new balance in retained earnings is $7,750,000 ($10,000,000 -
$2,250,000).
Stock dividends change the composition of stockholders’ equity
because they transfer to paid-in capital a portion of retained earnings.
Chapter However, total stockholders’ equity remains the same
14-27
Retained earnings
‫نخفض قيمة االسهم‬

common stock dividends dis

Chapter
14-28
2

Chapter
14-29
April 1 Declared a $1.50 cash dividend per share to stockholders of record
on April 15, payable May
May 1 Paid the dividend declared in April.
Journalize the transactions

Chapter
14-30
Mensa Corporation has 3,000 shares of 7%, $100 par value preferred
stock outstanding at December 31, 2010. At December 31, 2010, the
company declared a $105,000 cash dividend.
Determine the dividend paid to preferred stockholders and
common stockholders under each of the following scenarios
1)The preferred stock is noncumulative, and the company has not
missed any dividends in previous years.
2) The preferred stock is noncumulative, and the company did not pay
a dividend in each of the two previous years.
3) The preferred stock is cumulative, and the company did not pay a
dividend in each of the two previous years.

Chapter
14-31
Chapter
14-32
Retained
Retained Earnings
Earnings
Retained earnings is net income that a company retains
for use in the business.

Net income increases Retained Earnings and a net loss


decreases Retained Earnings..

A debit balance in Retained Earnings is identified as a


deficit. It is reported as a deduction in the stockholders’ equity
section
when a company has net income, it closes net income to retained earnings. The closing entry is
a debit to Income Summary and a credit to Retained Earnings. When a company has a net
loss (expenses exceed revenues), it also closes this amount to retained earnings The
closing entry in this case is a debit to Retained Earnings and a credit to Income Summary

Chapter
14-33
Retained
Retained Earnings
Earnings

Chapter
14-34
Retained
Retained Earnings
Earnings Restrictions
Restrictions
The balance in retained earnings is generally available for
dividend declarations. In some cases, there may be retained
earnings restrictions. These make a portion of the retained
earnings balance currently unavailable for dividends

Restrictions can result from:


1. Legal restrictions.

2. Contractual restrictions.

3. Voluntary restrictions.
Companies generally disclose retained earnings
Chapterrestrictions in the notes to the financial
14-35
Prior
Prior Period
Period Adjustments
Adjustments

Corrections of Errors
Result from:
 mathematical mistakes
 mistakes in application of accounting
principles
 oversight or misuse of facts

Corrections treated as prior period


adjustments
Adjustment made to the beginning balance of
retained earnings
Chapter
14-36 SO 2 Identify the items reported in a retained earnings
Prior
Prior Period
Period Adjustments
Adjustments
Companies report prior period adjustments in the retained earnings
statement. The companies add (or deduct, as the case may be) these
adjustments from the beginning retained earnings balance. This
results in an adjusted beginning balance. For example, assume that
General Microwave discovers in 2010 that it understated
depreciation expense in 2009 by $300,000 due to computational
errors. These errors overstated both net income for 2009 and the
current balance in retained earnings. , assuming a beginning balance
of $800,000 in retained earnings, General Microwave reports the
prior period adjustment as follows.

Chapter
14-37
Prior
Prior Period
Period Adjustments
Adjustments
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2010

Balance, January 1 $ 1,050,000


Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,110,000

Before issuing the report for the year ended December 31, 2010, you
discover a $50,000 error (net of tax) that caused the 2009 inventory to be
overstated (overstated inventory caused COGS to be lower and thus net
income to be higher in 2009. Would this discovery have any impact on
the reporting of the Statement of Retained Earnings for 2010?

Chapter
14-38 SO 2 Identify the items reported in a retained earnings
Retained
Retained Earnings
Earnings Statement
Statement
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2010

Balance, January 1, as previously reported $ 1,050,000


Prior period adjustment - error correction (50,000)
Balance, January 1, as restated 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $ 1,060,000

Chapter
14-39
Vega Corporation has retained earnings of $5,130,000 on January 1,
2010. During the year, Vega earned $2,000,000 of net income. It
declared and paid a $250,000 cash dividend. In 2010, Vega recorded an
adjustment of $180,000 due to the understatement (from a
mathematical error) of 2009 depreciation expense. Prepare a retained
earnings statement for 2010.

balance January1 as reported


Prior period adjustment
balance January1 as adjusted
Net income
Dividends
Balance December 31

Chapter
14-40
Retained
Retained Earnings
Earnings Statement
Statement

The company prepares the statement from the


Retained Earnings account.

Illustration 14-13 Debits


and credits to retained
earnings

Chapter
14-41 SO 2 Identify the items reported in a retained earnings
Retained
Retained Earnings
Earnings Statement
Statement

Chapter
14-42 SO 3 Prepare and analyze a comprehensive stockholders’ equity
The balance in retained earnings on January 1, 2008, for
Ettenger Inc, was $600,000. During the
year, the corporation paid cash dividends of $70,000 and
distributed a stock dividend of $8,000.
In addition, the company determined that it had
overstated its depreciation expense in prior years
by $50,000. Net income for 2008 was $100,000

Chapter
14-43
Statement
StatementAnalysis
Analysisand
andPresentation
Presentation

Stockholders’ Equity Analysis


Investors and analysts can measure profitability from the viewpoint of the common
stockholder by the return on common stockholders’ equity. This ratio shows how many
dollars of net income the company earned for each dollar invested by the common
stockholders. It is computed by dividing net income available to common stockholders
(which is net income minus preferred stock dividends) by average common
stockholders’ equity, if a company has preferred stock, we would deduct the amount of
preferred dividends from the company’s net income to compute income available to
common stockholders

Net Income Available to


Return on Common Stockholders
Common =
Stockholders’
Average Common Stockholders’
Equity
Equity

This ratio shows how many dollars of net income the company
Chapter earned for each dollar invested by the stockholders.
14-44
Walt Disney Company’s beginning-of-the-year and end-of-the year
common stockholders’ equity were $31,820 and $30,753 million
respectively. Its net income was $4,687 million, and no preferred
stock was outstanding. The return on common stockholders’ equity
ratio is computed as follows

Chapter
14-45
Statement
Statement Analysis
Analysis and
and Presentation
Presentation
Income Statement Analysis
The existence of preferred dividends slightly complicates the
calculation of EPS. When a corporation has both preferred and
common stock, we must subtract the current year’s preferred dividend
from net income, to arrive at income available to common
stockholders.
Net Income minus
Preferred Dividends
Earnings
Per Share =
Weighted-Average Common
Shares Outstanding
This ratio indicates the net income earned by
each share of outstanding common stock.
Chapter
14-46
To illustrate, assume that Rally Inc. reports net income of $211,000 on
its 102,500 weighted-average common shares. During the year it also
declares a $6,000 dividend on its preferred stock. Therefore, the amount
Rally has available for common stock dividends is $205,000 ($211,000 -
$6,000).
Earnings per share is $2 ($205,000 / 102,500).

If the preferred stock is cumulative, Rally deducts the dividend for the
current year, whether or not it is declared. Remember that companies
report earnings per share only for common stock.

Chapter
14-47
Statement
Statement Analysis
Analysis and
and Presentation
Presentation

Question
The income statement for Nadeen, Inc. shows
income before income taxes $700,000, income
tax expense $210,000, and net income $490,000.
If Nadeen has 100,000 shares of common stock
outstanding throughout the year, earnings per
share is:
a. $7.00. ($490,000 / 100,000 = $4.90)
b. $4.90.
c. $2.10.
d. No correct answer is given.
Chapter
14-48 SO 5 Compute Earnings Per Share.
Chapter
14-49
Chapter
14-50
Chapter
14-51

You might also like