Understanding Corporate Dividends, Retained Earnings, and Income Reporting in Accounting, Lecture notes of Accounting

Download Understanding Corporate Dividends, Retained Earnings, and Income Reporting in Accounting and more Lecture notes Accounting in PDF only on Docsity! 1 Introduction to Accounting 2 Modul 7 Chapter 15 CORPORATIONS: Dividends, Retained Earnings, and Income Reporting After studying this chapter, you should be able to: 1. Prepare the entries for cash dividends and stock dividends. 2. Identify the items that are 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. DIVIDENDS (STUDY OBJECTIVE 1)  Distribution by a corporation to its stockholders on a pro rata (proportional) basis  May be in the form of cash, property, scrip (promissory note to pay cash), or stock  May be expressed in one of two ways: 1. As a percentage of the par or stated value of the stock 2. As a dollar amount per share Cash Dividends  For a corporation to pay a cash dividend it must have: a. Retained earnings b. Adequate cash c. A declaration of dividends Entries for Cash Dividends Three important dates in connection with dividends:  Declaration date Board of Directors formally declares a cash dividend and a liability is recorded.  Record date Marks the time when ownership of outstanding shares is determined from the records maintained by the corporation.  Payment date Date dividend checks are mailed to the stockholders and the payment of the dividend is recorded. 2 Key Dividend Dates Declaration Date Assume that on December 1, 2005, the directors of Media General declare a 50 cents per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is $50,000 (100,000 x 50 cents) and the entry to record the declaration is: Record Date The purpose of the record date is to identify the persons or entities that will receive the dividend, not to determine the dividend liability. For Media General, the record date is December 22. No entry is required on this date because the corporation’s liability recognized on the declaration date is unchanged. Payment Date Assuming the payment date is January 20 for Media General, the entry on that date is: 5 Earnings per Share The formula to compute earnings per share when there is no preferred stock is as follows: 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑊𝑒𝑖𝑔 𝑕𝑡𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑕𝑎𝑟𝑒 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 = Earning Per Share Purposes and Benefits of a Stock Dividend Corporations issue stock dividends generally for one or more of the following reasons: 1. To satisfy stockholders’ dividend expectations without spending cash 2. To increase the marketability of stock by increasing the number of shares 3. To emphasize that a portion of stockholders’ equity has been permanently reinvested in the business and unavailable for cash dividends Stock Dividends Distinguished  SMALL stock dividend o Less than 20-25% of the corporation’s issued stock o Assign fair market value to small stock dividends Assumption that a small stock dividend will have little effect on the market price of the shares previously outstanding.  LARGE stock dividend o Greater than 20-25% of the corporation’s issued stock o Par or stated value per share is normally assigned Entries for Stock Dividends Assume that Medland Corporation has a balance of $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair value of its stock is $15 per share and the number of shares to be issued is 5,000 (10% of 50,000). The amount to be debited to Retained Earnings is $75,000 (5,000 x $15). 6 NOTE!!! Retained Earnings is debited for the fair market value of the stock issued because this is a SMALL stock dividend. Common Stock Dividends Distributable is credited for the par value of the dividend shares (5,000 x $10), and the excess is credited to Paid-in Capital. Statement Presentation of Common Stock Dividends Distributable Common Stock Dividends Distributable is a stockholders’ equity account; it is not a liability because assets will NOT be used to pay the dividend. If a balance sheet is prepared before the dividend shares are issued, the distributable account is reported in paid-in capital as an addition to common stock. Paid-in capital $ 500,00 Common Stock 50,000 Common Stock dividends distributable 550,000 When the dividend shares are issued, Common Stock Dividends Distributable is debited and Common Stock is credited Stock Dividend Effects Stock dividends change the composition of stockholders’ equity because a portion of retained earnings is transferred to paid-in capital. However, total stockholders’ equity and the par or stated value per share remain the same 7 Stock Splits  The issuance of additional shares to stockholders according to their percentage ownership o Number of shares increased in the same proportion that par or stated value per share is decreased  Has no effect on total paid-in capital, retained earnings, and total stockholders’ equity.  Not necessary to formally journalize a stock split Stock Split Effects Assume instead of a 10% dividend, Medland Corporation splits its 50,000 shares of common stock on a 2-for-1 basis. This means that one share of $10 par value stock is exchanged for two shares of $5 par value stock. A stock split DOES NOT have any effect on total paid-in capital, retained earnings, and total stockholders’ equity. However, number of shares increases and book value per share decreases. Differences Between the Effects of Stock Splits and Stock Dividends 10 NOTE: REPORTING THE CORRECTION IN THE CURRENT YEAR’S INCOME STATEMENT WOULD BE INCORRECT BECAUSE IT APPLIES TO A PRIOR YEAR’S INCOME STATEMENT. Debits and Credits to Retained Earnings Retained Earnings 1. Net Loss 1. Net income 2. Prior period adjustments for overstatement of net income 2 Prior period adjustment for understatement of net income 3. Cash dividends and stock dividends 4. Some disposals of treasury stock Many corporations prepare a retained earnings statement to explain the changes in retained earnings during the year. COMPREHENSIVE STOCKHOLDERS’ EQUITY SECTION (STUDY OBJECTIVE 3)  Common Stock Dividends Distributable o Shown Under Capital Stock In Paid-In-Capital  Retained Earnings restrictions o Disclosed In The Notes To The Financial Statements CORPORATION INCOME STATEMENTS (STUDY OBJECTIVE 4)  Includes essentially the same sections as in a proprietorship or a partnership except for the reporting of income taxes  For tax purposes, corporations are considered to be a separate legal entity.  Income tax expense o Reported in a separate section of the corporation income statement before net income Income Statement with Income Taxes 11 Income Tax Expense Using the preceding Income Statement, the adjusting entry for income tax expense at December 31, 2005, would be as follows: EARNINGS PER SHARE (STUDY OBJECTIVE 5)  Frequently reported in the financial press  Used by stockholders and investors to evaluate profitability  Indicates the net income earned by each share of outstanding common stock EPS and Preferred Stock Dividends When a corporation has both preferred and common stock, the current year’s dividend declared on preferred stock is subtracted from net income to arrive at income available to common stockholders. 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. 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑚𝑖𝑛𝑢𝑠 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑑 𝑑𝑒𝑣𝑖𝑑𝑒𝑛𝑠 𝑊𝑒𝑖𝑔 𝑕𝑡𝑒𝑑 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑕𝑎𝑟𝑒 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛 𝑔 = Earning Per Share ($211,000−$6,000) 102,500 = $2 EPS Therefore, Rally has $205,000 ($211,000 - $6,000) available for common stock dividends. EPS is $2 ($205,000 / 102,500). REVIEW 1. The date a cash dividend becomes a binding legal obligation to a corporation is the a. Declaration date. b. Earnings date. c. Payment date. d. Record date. 12 2. 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. b. $4.90. c. $2.10. d. No correct answer is given. 3. PT Abadi Jaya is an electronic wholesaler located in Jember. During its current fiscal year, ended December 31, 2008. PT Abadi Jaya completed the following selected transactions: Feb. 3 Purchased 2.500 shares of its own common stock at Rp26.000,00, recording the stock at cost. (Prior to the purchase, there were 40.000 shares of Rp20.000,00 per common stock outstanding) May 1 Declared a semiannual dividend aof Rp1.000,00 on the 10.000 shares of preferred stock and a Rp300 dividend on the common stock to stockholders of record on May 1, payable on June 15. June 15 Paid the cash dividend Sept. 23 Sold 1.000 shares of treasury stock at Rp28.000,00, receiving cash Nov. 1 Declared semiannual dividend of Rp1.000,00 on the preferred stock and Rp300,00 on the common stock. In addition, a 5% common stock dividend was declared on the common stock outstanding, to be capitalized at the fair market value of the common stock, which is estimated at Rp30.000,00 Dec. 1 Paid the cash dividend and issued the certificates for the common stock dividend Instructions: Journalized the entries to record the transaction for PT Abadi Jaya Reference Weigandt, Kieso, and Kimmel. (2005). Accounting Principles, 6th Ed. Canada: John Wiley and Sons. Reeve, James M, Caarl S. Waren and Jonathan E. Duchac. Principles of Accounting. Singapore: Cengage Learning Asia Pte Ltd. (R)