12-1
Chapter
12
INCOME AND CHANGES IN
RETAINED EARNINGS
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Reporting the Results of Operations
Information about net income can be divided
into two major categories
Normal, recurring revenue and
expense transactions.
Income from
continuing
operations.
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1. Results of
discontinued
operations.
Unusual, nonrecurring events
that affect net income.
2. Impact of
extraordinary
items.
3. Effects of
changes in
accounting
principles.
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12-3
Matrix, Inc.
Income Statement
For the Year Ended December 31, 2007
Net Sales
Cost of goods sold
Gross margin
Operating expenses:
Selling expenses
General & admin. exp.
Loss on settlement of lawsuit
Income taxes
Income from continuing operations
Discontinued operations
Extraordinary items
Net income
$
$
$
9,000,000
4,000,000
5,000,000
This tax expense
1,500,000
920,000not include
does
80,000 of unusual,
effects
750,000
3,250,000
nonrecurring
items.
$
1,750,000
(175,000)
These unusual,
(52,500)
nonrecurring
items
$
1,522,500
are each reported
net of taxes.
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
Discontinued Operations: When a company has a
discontinued operation, it must report the income
or loss from operating a segment that has been
discontinued, and the gain or loss on the sale of
the segment net of taxes.
 Extraordinary items are gains and losses that are
both unusual and infrequent in occurrence.
Some examples include losses from natural
disasters and expropriation of property by a
foreign government. Extraordinary items are also
reported net of taxes.
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12-5
Discontinued Operations
During 2007, Matrix, Inc. sold an unprofitable
segment of the company. The segment had a
net loss from operations during the period of
$150,000 and a loss on the sale of its assets
of $100,000. Matrix reported income from
continuing operations of $1,750,000. All
items are taxed at 30%.
How will this appear on the income statement?
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Discontinued Operations
Loss on segment operations
Less: Tax benefits ($150,000 × 30%)
Net loss
$ (150,000)
45,000
$ (105,000)
Loss on disposal of assets
Less: Tax benefits ($100,000 × 30%)
Net loss
$ (100,000)
30,000
$ (70,000)
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Discontinued Operations
Income Statement Presentation:
Income from continuing operations
Discontinued operations:
Loss on operations (net of
tax benefit of $45,000)
Loss on disposal of assets (net
of tax benefits of $30,000)
Earnings before extraordinary item
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$ 1,750,000
(105,000)
(70,000)
$ 1,575,000
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12-8
Extraordinary Items
During 2007, Matrix, Inc. experienced a loss of
$75,000 due to an earthquake at one of its
manufacturing plants in Nashville. This was
considered an extraordinary item. The
company reported income before extraordinary
item of $1,575,000. All gains and losses are
subject to a 30% tax rate.
How would this item appear on the 2007 income
statement?
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Extraordinary Items - Example
Extraordinary Loss $ (75,000)
Less: Tax Benefits
($75,000 × 30%)
22,500
Net Loss
$ (52,500)
Income Statement Presentation:
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Earnings Per Share (EPS)
A measure of the company’s profitability and
earning power for the period.
Earnings
Per Share
Net
=
Income
÷
Weighted Average
Number of Shares
Outstanding
Based on the number of shares
issued and the length of time
that number remained
unchanged.
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Earnings Per Share (EPS)
Remember that Matrix, Inc. has income from
continuing operations of $1,750,000. The aftertax loss from discontinued operations was
$175,000 and the extraordinary loss was
$52,500. Assume that Matrix has 156,250
weighted average shares outstanding.
Prepare a partial income statement showing the
EPS for income from continuing operations and
for the other special items.
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Earnings Per Share (EPS)
Income from continuing operations
Loss from discontinued operations
Income before extraordinary items and
cumulative effect of accounting change
Extraordinary loss
Net Income
Income
Statement
Amounts
EPS
$ 1,750,000 $ 11.20
(175,000)
(1.12)
$
1,575,000 $
(52,500)
$
1,522,500 $
10.08
(0.34)
9.74 *
* Rounded.
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Earnings Per Share (EPS)
If preferred stock is present, subtract preferred
dividends from net income prior to computing EPS.
Earnings
Per Share
=
Net Income - Preferred Dividends
Weighted Average Number of
Common Shares Outstanding
EPS is required to be reported
in the income statement.
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Basic and Diluted Earnings per Share
If a company has convertible securities,
like convertible preferred stock
outstanding, the conversion of these
securities to common stock may dilute
(reduce) earnings per share.
Diluted earnings per share reflect the
impact of the assumed conversion of
the securities on earnings.
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Price-earnings Ratio (P/E)
Often, the Price-Earnings Ratio is used to evaluate
the reasonableness of a company’s stock price.
Price-Earnings
Current Stock
=
÷
Ratio
Price
Earnings Per
Share
Let’s examine this
further.
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Accounting for Cash Dividends
Declared by Board
of Directors.
Not legally
required.
Creates liability
at declaration.
Requires sufficient
Retained Earnings
and Cash.
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Dividend Dates
Date of Declaration
• Board of Directors declares the dividend.
• Record a liability.
On March 1, 2007, the Board of Directors of Matrix, Inc.
declares a $1.00 per share cash dividend on its 500,000
common shares outstanding. The dividend is payable to
stockholders of record on April 1, and paid on May 1.
Date
Description
Mar. 1 Retained Earnings
Dividends Payable
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Debit
Credit
500,000
500,000
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12-18
Dividend Dates
Ex-Dividend Date
• The day which serves as the ownership
cut-off point for the receipt of the most
recently declared dividend.
Date
Description
Debit
Credit
Apr. 1
NO ENTRY
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Dividend Dates
Date of Record
• Stockholders holding shares on this date will
receive the dividend. (No entry)
April 2007
X
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Dividend Dates
Date of Payment
• Record the payment of the dividend to
stockholders.
Date
Description
May 1 Dividends Payable
Cash
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Debit
Credit
500,000
500,000
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12-21
Accounting for Stock Dividends
Distribution of additional shares of stock to
stockholders.
No change in total
stockholders’ equity.
No change in par
values.
All stockholders
retain same
percentage
ownership.
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Summary of Effects of Stock
Dividends and Stock Splits
Small Stock
Dividend
Large Stock
Dividend
Stock Splits
Total
Stockholders'
Equity
Common Stock
Paid-in Capital
No Effect
No Effect
No Effect
Increases
Increases
Increases
No Effect
No Effect
No Effect
Retained Earnings
Decreases
Decreases
No Effect
Increases
Increases
Increases
No Effect
No Effect
Decreases
Number of Shares
Outstanding
Par Value per
Share
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12-23
Prior Period Adjustments
The correction of an error identified as
affecting net income in a prior period.
Adjust retained
earnings retroactively.
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The adjustment
should be disclosed
net of any taxes.
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Statement of Retained Earnings
with Prior Period Adjustment
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