Chapter 20
1
Corporate Taxes,
Retained Earnings,
and Dividends
College Accounting
10th Edition
McQuaig
McQuaig
Bille
Bille
Nobles
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
20–1
© 2011 Cengage Learning
Procedure for Recording
and Paying Income Taxes
 Corporate net income is determined much
like that of sole proprietorships and
partnerships.
 The net income of a sole proprietorship
and the distribution of shares of net income
of a partnership are taxable as part of each
owner’s personal income.
 Corporations must pay income taxes in its
own name.
20–2
Corporate Income
Tax Rates
Example: Taxable Income of $10,800,000
$3,400,000 + [0.35 x $($10,800,000 – $10,000,000)] = $3,680,000
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Income Tax Entries for a Corporation
Red Velvet Cupcakes, Inc., estimates that its federal
income tax for the forthcoming fiscal year will be
$30,830. The firm’s accountant records four quarterly
payments; the first on April 15.
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Income Tax Entries for a Corporation
Red Velvet Cupcakes’s accountant determines that the
taxable income of the corporation for the year is $33,170
and that the corporation owes an additional $2,340.
The corporation is required to make full payment of its final
tax with its income tax return, which would be recorded as:
Income Tax Entries for
a Corporation
Red Velvet Cupcakes’s total tax for the year is $33,170.00.
First quarterly installment of estimated federal income tax
$ 7,707.50
Second quarterly installment of estimated federal income tax
7,707.50
Third quarterly installment of estimated federal income tax
7,707.50
Fourth quarterly installment of estimated federal income tax
7,707.50
Additional tax owed
2,340.00
Total tax
$33,170.00
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Reasons why net income shown on the
income statement may differ from the
income reported for tax purposes.
 The depreciation method used for income
statement purposes may differ from the
method used for tax purposes.
 Some items listed on the income statement are
not taxable.
 A corporation may capitalize certain types of
expenditures as assets on the financial
statements, and list them on the tax return as
an expense.
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Closing Entries for a Corporation
Red Velvet Cupcakes, Inc., had revenues of $996,000 and
expenses of $868,000 at the end of the fiscal year.
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Closing Entries for a Corporation
STEP 1. Close revenue accounts into Income
Summary.
STEP 2. Close expense accounts into Income
Summary.
STEP 3. Close Income Tax Expense into Income
Summary by the amount of the actual
income tax for the year.
STEP 4. Close Income Summary into Retained
Earnings by the amount of the net
income.
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Summary of Entries in T Account Form
Reasons for Appropriating
Retained Earnings
 Because a corporation declares dividends out of
its Retained Earnings, the amount of dividends
is necessarily limited to the amount of Retained
Earnings.
 The local board of directors may wish to earmark
part of Retained Earnings for some specific
purpose. Such a restriction constitutes an
appropriation of Retained Earnings. A
common reason for appropriating Retained
Earnings is future expansion.
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Reasons for Appropriating
Retained Earnings
Red Velvet Cupcakes, Inc., plans to erect a new store
building. It decides to restrict, or appropriate, Retained
Earnings for a total amount of $300,000 at a rate of
$50,000 per year for six years.
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Reasons for Appropriating
Retained Earnings
 The appropriation of Retained Earnings does
not represent a separate cash fund of $50,000.
 If the corporation does not declare and pay out
these dividends, then the firm is preserving its
net assets (assets minus liabilities), particularly
cash.
 When the building is bought or erected, the
corporation no longer needs to restrict Retained
Earnings, so the following entry is needed.
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Reasons for Appropriating
Retained Earnings
20–14
Reasons for Appropriating
Retained Earnings
 Retained Earnings Appropriated for Plant Expansion (no
specific objective stated)
 Retained Earnings Appropriated for Bond Indebtedness
(an obligation imposed b contract)
 Retained Earnings Appropriated for Self-Insurance
(workers’ compensation or medical insurance for
employees)
 Retained Earnings Appropriated for Inventory Losses (in
the event of a price drop)
 Retained Earnings Appropriated for Contingencies (in
the event of a “rainy day”)
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Declaration and Payment
of a Dividend
 A dividend is a distribution—of cash or other
assets or shares of stock—that a corporation
makes to its stockholders.
 A cash dividend is the most common form of
dividend. It is expressed as a specific amount
per share.
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Dividend Dates
Three significant dates are involved in the
declaration and payment of a dividend.
1. Date of declaration
2. Date of record
3. Date of payment
On January 30, the board of directors of Red Velvet
Cupcakes, Inc. declares a quarterly; cash dividend of
$0.91 per share on 5,000 shares to stockholders of
record on February 11, payable on February 20.
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Dividend Dates
Current Liability
Date of Declaration
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Dividend Dates
Date of Payment
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Retained Earnings Account
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Cash Dividends on
Cumulative Preferred Stock
 Preferred stock can be either cumulative
preferred stock or noncumulative preferred
stock.
 Cumulative preferred stock accrues dividends,
and noncumulative preferred stock does not
accrue dividends.
 Any dividends not paid in the past on
cumulative preferred stock are called
dividends in arrears.
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Cash Dividends on
Cumulative Preferred Stock
 Red Velvet Cupcakes, Inc., has outstanding 10,000
shares of $30 par, 8 percent, cumulative preferred stock
and 80,000 shares of $15 par value common stock.
 The corporation declares and pays dividends.
$24,000 for dividends in arrears and
$24,000 for the current year
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Stock Dividends
 A stock dividend is a distribution, on a pro rata
basis, of additional shares of a company’s stock
to the stockholders.
 The dividend consists of shares of stock rather
than cash.
 Stock dividends are usually issued by
corporations that retain cash in order to finance
expansion.
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Stock Dividends
The board of directors of Mom’s Bakery, Inc., declares a 10
percent stock dividend on October 11 of Year 3 to
stockholders of record as of November 1, distributable on
November 16. The current market value is $47 per share
(par value $40).
10% of 5,000 = 500 shares
(continued)
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Stock Dividends
A stockholders’
equity account
Date of Declaration
20–25
Stock Dividends
Date of Distribution (Payment)
 A stock dividend—unlike a cash dividend—does not
result in a reduction of assets.
 The stock dividend increases the Capital Stock
accounts and decreases the Retained Earnings
account without changing total stockholders’ equity.
 The stock dividend has no effect on the proportionate
share of ownership held by an individual stockholder.
Reasons for Issuing Stock Dividends
1. Stock dividends appease stockholders by
giving them additional shares of stock.
2. Stock dividends tend to increase the
marketability of the company’s stock by
increasing the number of shares outstanding
and thereby decreasing the market price per
share.
3. Stock dividends enable stockholders to
postpone any income tax liability until they
sell the shares.
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Stock Split
 When there is a stock split, a corporation
splits or sub-divides its stock, on the basis of
its par or stated value, and issues a
proportionate number of additional shares.
 A corporation with 10,000 shares of $50 parvalue stock outstanding reduces the par
value to $25 and increase the number of
shares to 20,000 through a 2-for-1 split.
 At the date of declaration, a memorandum
notion is made.
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Stock Split
Because there is no change in Retained Earnings, a
journal entry is not required.
20–29
Effect of Dividends and Stock
Splits on Assets and
Stockholders’ Equity
20–30
Minute Book
 The minute book is an important source
document for any accounting entries
involving the declaration of dividends and
the appropriation of Retained Earnings.
 It is an electronic narrative of all actions
taken at official meetings of the board of
directors.
 It may contain details relating to purchasing
property and equipment, obtaining bank
loans, and so on.
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Statement of Retained Earnings and
Balance Sheet for a Corporation
 Changes in Retained Earnings are reported
on a separate financial statement called a
statement of retained earnings.
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Statement of Retained Earnings
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Balance Sheet
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Balance Sheet
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Balance Sheet
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Full Disclosure
 The guideline of full disclosure requires that
anyone preparing a financial statement include
enough information so that the statement is
complete.
 Example: A note about a lawsuit in which the
company is involved.
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Materiality
 The guideline of materiality states that relatively
important data are included in financial reports.
Transactions that have very little effect on the
results shown in financial statements and would
not be likely to influence decisions made by
users are considered immaterial.
 Example: Rounding numbers on the published
annual report of a large corporation to make the
statements easier to read is acceptable because
the impact is immaterial.
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Conservatism
 To be conservative means to take the safe
route. According to the guideline of
conservatism, accountants use the alternative
that is the least likely to result in an
overstatement of income or asset value.
 Example: An accountant is estimating an
amount of money to be received in the future.
The accountant must choose between $12,000
and $22,000. Conservatism requires the
accountant to choose the smaller amount.
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