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ACC613 Lecture 6 Accounting for Dividends, Reserves and Financial Statements.

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Bachelor of Accounting
ACC613 – Intermediate Financial
Accounting 1
Topic:
Accounting for Dividends,
Reserves and Financial
Statements.
Prepared by John Awakari
Lecture outline:
• Introduction
• Accounting for Dividends
• Cash Dividends
• Preference dividends
• Share dividends
• Accounting for Reserves
• Creation of reserves
• Disposal of reserves
• Income tax
• Preparing the financial statements.
Introduction
• Sole traders venture into business to make profit.
• Shareholders (investors) invest in companies expecting something in
return.
• The return on their investment is called: Dividend.
• On the other hand, companies do put certain amount of money aside
for future expansion or to meet future short falls etc…. So what has
been put aside is called Reserve.
Dividends
• A distribution of cash or other assets or of a company’s own share to
its shareholders.
• Cash dividends are the most common.
• Legal requirements in the Company Act, specify that a company must
not pay dividend unless:
• The company’s asset exceed its liabilities immediately before the dividend is
declared and the excess is sufficient for the payment of the dividend.
• The payment of the dividend is fair and reasonable to the company’s
shareholders as a whole.
Payments of Dividend.
• In the past dividends could only be paid out of profit.
• New approach:
• Dividends can be paid out of:
• Capital
• Retained earnings and
• Reserves.
• Before payment, dividend must be declared and recorded.
• Declaration should include:
• the amount
• the time of payment
• the method of payment.
Two types of dividend
• Cash dividends
• Preference dividends
Cash dividends
• Normally stated as so many cents per share.
• Consist of interim and final dividends.
• To ensure dividends are paid to the rightful owner of
the shares, dividend are often declared on one date
and are payable on some future date to shareholders.
Journal entry
To record declaration of dividend
Dr Retained Earnings
Cr Final dividend payable
To record the payment of dividend
Dr Final dividend payable
Cr Cash at Bank.
Share dividends
• Is a pro rata distribution of additional shares by a company
to its shareholders.
• Normally consisting of the distribution of additional ordinary
shares to ordinary shareholders. Share dividends should be
distinguished from cash dividends.
• Share dividends have no effect on company assets or on total
equity. The only effect, is the transfer of retained earnings or
other reserves to contributed share capital.
• Share dividend often are declared by successful companies
that have used their profitable resources to expand
operations.
Share dividends
• The declaration of share dividend gives shareholders some
additional shares as evidence of the increase in their equity
in the company. In effect, shareholders receive nothing
more than the equity they already have.
• When share dividends are declared and paid, retained
earnings or other reserves are transferred to share capital.
Journal entry
•To record declaration of share dividend out
of general reserve.
Dr General Reserve
Cr Share Capital
Illustration.
Equity
Share capital: 250 000 ordinary shares, fully paid @ $1
General Reserve
Retained earnings
$250 000
300 000
400 000
$950 000
Illustration.
• Assume that on 20 December, the board of
directors declares out of the general reserve a
share dividend of 1 share value for every 20
shares held, to be distributed on 10 January to
shareholders registered on 31 December.
Journal entry
Dr General Reserve
$12 500
Cr Share Capital
(Distribution of a 1 for every
20 share dividend on 250 000
Ordinary shares, at a value of $1 each)
12 500
Effect
• To decrease general reserve by $12 500 and to increase
share capital by the same amount.
Ordinary share capital
General reserve
Retained earnings
Before
After
share dividend share dividend
$250 000
$262 500
300 000
287 500
400 000
400 000
$950 000
$950 000
Reserves
• Represent those items of equity other an contributed by
owners.
• Retained earnings is the main one.
• Also out of retained earnings many other reserves are
created to set aside equity for particular purpose.
• Some are created in order to comply with accounting
standards.
• E.g. Asset revaluation reserve etc.
Creation of reserves
Journal Entry
Dr Retained Earnings
Cr Reserve
(Creation of a reserve by an appropriating profits)
Revaluation of Assets upwards
Journal Entry
Dr Asset
Dr Accumulated Depreciation
Cr Revaluation Surplus
(Revaluation upwards of the carrying amount of a
non current assets to fair value)
Disposal of reserves
• May be written off or reduced either by:
• paying a cash dividend or
• share dividend from the reserve or by
• transferring the reserve account back to the
Retained Earnings account.
Journal Entry
Dr Reserve
xxx
Cr Retained Earnings
xxx
(Transfer of reserve account back to retained
earnings)
Income Tax
• Once the company has determined its profit for the
period, a further expense for income tax must be
deducted before arriving at the company’s final profit
after tax.
• Income tax payable by a company is based on the
company’s taxable income as determined under the
Tax Act and not the company’s accounting profit.
Preparing the financial statements
• This has been prepared after the determination of all its assets,
liabilities, equities (including dividends and reserves), income
(including revenues) and expenses.
• It is prepared at the end of the financial year.
• For a company, four financial statements are usually prepared.
A.
B.
C.
D.
An Income Statement
Statement of changes in equity
A balance sheet.
A statement of cash flow.
Illustrative example: Preparation of financial
statements.
Refer to attach handout
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