Retained Earnings, Treasury Stock, and the Income Statement

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Retained Earnings, Treasury
Stock, and the Income Statement
Chapter 14
Retained Earnings
and Dividends
Retained Earnings shows the amount of
income allowed to accumulate from the
beginning of the corporation’s life to the
present.
 Retained Earnings represents a claim on
assets, but it is not cash.

Retained Earnings
and Dividends
The balance in the Income Summary
account is closed to Retained Earnings at
period end.
 Dividends are distributions to the
stockholders.
 To declare dividends there must be
adequate retained earnings.

Objective 1
Account for stock dividends.
Stock Dividends
What are stock dividends?
 They are a proportional distribution of a
corporation’s own stock to shareholders.
 They do not change total stockholders’
equity.
 A stock dividend is a transfer of retained
earnings to contributed capital.

Small Stock Dividend Example
The dividend is valued at the product of
the number of shares distributed times the
market price at declaration date.
 San Diego Company, with 300,000 shares
of $2 par value common stock outstanding,
declares a 15% stock dividend when the
shares are trading at $20.

Small Stock Dividend Example
How much stock do the shareholders
receive?
 300,000 × 15% = 45,000 shares
 45,000 at $20 per share = $900,000, and
45,000 at $2 per share = $90,000

What is the entry when the dividend is distributed?
Small Stock Dividend Example
Retained Earnings
900,000
Common Stock
90,000
Paid-in Capital in
Excess of Par
810,000
15% common stock dividend distributed
Large Stock Dividend
This significantly increases the number of
shares outstanding and is likely to reduce
the per share price.
 A common practice is to transfer the par
value of the dividend shares from Retained
Earnings to Common Stock.

Large Stock Dividend Example
A 50% dividend is declared on a company’s
$1 par value common.
 There are 200,000 shares outstanding.

Retained Earnings 100,000
Common Stock
100,000
50% common stock dividend distributed
Stock Split
This is an increase in the number of
authorized, issued, and outstanding shares.
 It is a reduction in the par value.
 The market value is usually affected
proportionately.

Stock Split
A 5-for-1 stock split means that the
company would have five times as many
shares outstanding after the split as it had
before.
 Each share’s par value would be divided
by five.

Stock Split Example
Prior to a 5-for-1 split, San Diego Company
had 500,000 shares of $10 par common
stock authorized and 100,000 issued.
 After the split, 2,500,000 are authorized.
 500,000 are issued.
 What is the par value per share?
 $10 ÷ 5 = $2

Objective 2
Distinguish stock splits
from stock dividends.
Similarities Between Stock
Splits and Stock Dividends
Both increase the number of shares
of stock owned per stockholder.
Neither change the investor’s
cost of the stock they own.
Neither type of income creates
taxable income for the investor.
Differences Between Stock
Splits and Stock Dividends
A stock dividend shifts an amount from
retained earnings to paid-in capital.
 The par value per share remains unchanged.
 A stock split affects no account balance.
 It changes the par value of the stock.
 It increases the number of shares of stock
authorized, issued, and outstanding.

Objective 3
Account for treasury stock.
Treasury Stock...
are shares that a company has issued and
later reacquired.
 Purchasing treasury stock decreases assets
and stockholders’ equity.
–
Treasury Stock Example

San Diego Company purchased 1,000
shares of its own $10 par value common
stock at $20 per share (500,000 shares are
authorized, 10,000 are issued.)
Treasury Stock
20,000
Cash
20,000
Purchased 1,000 shares of treasury stock
Treasury Stock Example
Stockholders’ Equity
(Before purchase of treasury stock)
Common stock, $10 par, 10,000 issued $100,000
+ Paid-in capital in excess of par
800,000
= Total paid-in capital
$900,000
+ Retained earnings
50,000
= Total stockholders’ equity
$950,000
Treasury Stock Example
(After purchase of treasury stock)
Common stock, $10 par, 10,000 issued,
9,000 outstanding
$100,000
+ Paid-in capital in excess of par
800,000
+ Retained earnings
50,000
= Subtotal
$950,000
– Treasury stock, 1,000 shares
20,000
= Total stockholders’ equity
$930,000
Sale of Treasury Stock Example
No gain or loss is recognized on the sale of
treasury shares.
 Excess of sales price over cost is credited to
Paid-in Capital-Treasury Stock transactions.
 Assume that 100 shares of treasury stock
are sold at $22.

Sale of Treasury Stock Example
Cash
2,200
Treasury Stock
2,000
Paid-In Capital from
Treasury Stock
200
Sold 100 shares of treasury stock
What if 100 shares of treasury stock are sold at $18?
Sale of Treasury Stock Example
Cash
1,800
Paid-In Capital from
Treasury Stock
200
Treasury Stock
2,000
Sold 100 shares of treasury stock
Sale of Treasury Stock Example
What if the resale price is less than cost?
 Debit Paid-in Capital from Treasury Stock
Transactions.
 Debit Retained Earnings if the Paid-in
Capital from Treasury Stock Transactions
is too small.

Retirement of Stock...
decreases the outstanding stock of the
corporation.
 Retired shares cannot be reissued.
 There is no gain or loss on retirement.
–
Objective 4
Report restrictions on
retained earnings.
Restrictions on
Retained Earnings
Restrictions are reported on the notes to the
financial statements.
 Appropriations are restrictions on retained
earnings that are recorded by formal journal
entries.
 Retained earnings appropriations are rare.
 There are many acceptable variations in
format for presenting stockholders’ equity.

Variations in Reporting
Stockholders’ Equity
1
2
3
4
The heading Paid-in Capital does not
appear.
Preferred stock is often reported in a single
amount.
Additional Paid-in Capital appears as a
single amount.
Total stockholders’ equity is not specifically
labeled.
Objective 5
Identify the elements of a
complex income statement.
The Corporate Income Statement
(Continuing Operations)
Allied Corporation
Income Statement
Year Ended December 31, 20x5
Net sales revenue
Cost of goods sold
Gross profit
Operating expenses
Operating income
$500,000
240,000
260,000
181,000
79,000
The Corporate Income Statement
(Continuing Operations)
Operating income
Other gains (losses):
Loss on restructuring operations
Gain on sale of machinery
Income from continuing operations
before income tax
Income tax expense
Income from continuing operations
79,000
10,000
21,000
90,000
36,000
54,000
The Corporate Income Statement
(Special Items)
Discontinued operations income of
$35,000, less income tax of $14,000
Income before extraordinary item
and cumulative effect of change in
depreciation method
Extraordinary flood loss, $20,000,
less income tax savings of $8,000
Cumulative effect of change in
depreciation method, $10,000,
less income tax of $4,000
Net income
21,000
75,000
–12,000
6,000
$69,000
The Corporate Income Statement
(Earnings per Share)
Earnings per share of common stock
(20,000 shares outstanding):
Income from continuing operations
Income from discontinued operations
Income before extraordinary item
and cumulative effect of change
in depreciation method
Extraordinary loss
Cumulative effect of change in
depreciation method
Net income
$2.70
1.05
3.75
–0.60
0.30
$3.45
Analyzing the Corporate
Income Statement
Extraordinary items are both unusual and
infrequent.
 They are reported net of their tax effect.
 The environment must be considered when
determining whether an item is unusual.
 Accounting rules specify extraordinary
items.

Analyzing the Corporate
Income Statement
Extraordinary items include expropriations.
 Also, they include losses due to natural
disasters.
 hurricane
 flood
 fire

Analyzing the Corporate
Income Statement

1
2
Changes in accounting methods can result
from either of two scenarios:
Adoption of a newly required accounting
standard
Changing accounting methods
Earnings Per Share Example
On January 1, San Diego Company had
100,000 common shares outstanding.
 On May 1, the company purchased 15,000
treasury shares.
 On September 1, they issued 50,000 new
shares.
 Income for the year was $135,000.
 What are the earnings per share?

Earnings Per Share Example
No. of Shares
Outstanding
100,000
×
85,000
×
135,000
×
Total
Fraction
of Year
4/12
=
4/12
=
4/12
=
Weighted
Average
33,333
28,333
45,000
106,666
EPS = $135,000 ÷ 106,666 = $1.27
Earnings Per Share
and Preferred Stock
Preferred dividends must be subtracted from
income subtotals (income from continuing
operations, income before extraordinary
items, and net income) in the computation
on EPS.
 They are not subtracted from income or loss
from discontinued operations, or from
extraordinary gains or losses.

Earnings Per Share
and Preferred Stock

1
2
Corporations with complex capital structures
present two sets of EPS amounts.
EPS based on outstanding common shares
(basic EPS)
EPS based on outstanding common shares plus
the number of additional common shares that
would arise from conversion of the preferred
stock
Reporting
Comprehensive Income
FASB Statement 130 requires companies
with certain gains and losses to report a
comprehensive income figure.
 Comprehensive income is the company’s
change in total stockholders’ equity from all
sources other than from the owners of the
business.

Reporting
Comprehensive Income
FASB 130 New Comprehensive
Income Components
Unrealized gains or losses
on certain investments
Foreign-currency
translation adjustment
Prior Period Adjustments...
are corrections to the beginning balance of
Retained Earnings for errors of an earlier
period.
 The correcting entry includes a debit or
credit to Retained Earnings for the error
amount.
 It also includes a debit or credit to the asset
or liability account that was misstated.
–
Statement of Retained Earnings
Example
De Graff Corporation
Year Ended December 31, 20x5
Retained earnings, Dec 31, 20x4 (original)
Less: Prior-period adjustments – to correct
error in the 20x4 income tax
Retained earnings, Dec. 31, 20x4, adjusted
Net income for 20x5
Total
Deduct: Dividends declared in 20x5
Retained earnings, December 31, 20x5
$390,000
10,000
$380,000
114,000
$494,000
41,000
$453,000
Objective 6
Prepare a statement of
stockholders’ equity.
Statement of
Stockholders’ Equity

Most companies report a statement of
stockholders’ equity, which is more
comprehensive than a statement of retained
earnings.
Statement of
Stockholders’ Equity...
reports changes in all categories of equity
during the period.
 It reports stock transactions, dividends, and
the effects of treasury stock transactions.
–
Statement of Stockholders’
Equity Example
Balance, December 31, 20x4
Issuance of stock
Net income
Cash dividends
Stock dividends – 8%
Purchase of treasury stock
Sale of treasury stock
Balance, December 31, 20x5
Additional
Common Paid-in Retained
Stock
Capital Earnings
$ 80,000 $160,000 $130,000
20,000
65,000
69,000
(21,000)
8,000
26,000
(34,000)
13,000
$108,000 $264,000 $144,000
Statement of Stockholders’
Equity Example
Balance, December 31, 20x4
Issuance of stock
Net income
Cash dividends
Stock dividends – 8%
Purchase of treasury stock
Sale of treasury stock
Balance, December 31, 20x5
Treasury
Stock
Total
$(25,000) $345,000
85,000
69,000
(21,000)
-0(9,000)
(9,000)
4,000
17,000
$(30,000) $486,000
End of Chapter 14
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