Corporations:
Retained Earnings and the
Income Statement
Chapter 12
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1
Retained Earnings
• All net income minus net losses minus
dividends
• Negative balance in Retained Earnings deficit
• Not a fund of cash
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2
Objective 1
Account for stock dividends
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3
Stock Dividend
• Proportional distribution of corporation’s
own stock to shareholders
• Does not change total stockholders’ equity
• Transfer of retained earnings to
contributed capital – no assets are
distributed
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4
Entries for Stock Dividend
Small
• Distribution is < 2025% of previously
outstanding shares
• Debit retained
earnings for market
value of shares to be
distributed
Large
• Distribution is > 25% of
previously outstanding
shares
• Debit retained earnings
for par or stated value
of shares
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5
E12-13
How many shares of stock are distributed?
50,000 × 10% = 5,000 shares
How much will be debited to retained earnings?
5,000 shares x $14 = $70,000
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6
E12-13
GENERAL JOURNAL
DATE
Apr
DESCRIPTION
REF
30 Retained Earnings
Common Stock
Paid in Capital in Excess of
Par, Common
DEBIT
CREDIT
70,000
5,000
65,000
USE MARKET
VALUE
USE PAR
5,000
shares
x $14
Common
stock
= 5,000
shares x $1
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7
E12-13
The number of shares
Retained earnings decreased
issued increased.
Stockholders’ Equity:
Paid in Capital:
Common stock, $1 par, 100,000 shares
authorized,
55,000 shares
issued
Total stockholders’
equity
is
Paid in capital the
in excess
same of par
Total paid in capital
Retained earnings ($120,000-70,000)
Total stockholders’ equity
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$55,000
265,000
$320,000
50,000
$370,000
8
Stock Splits
• Increases the number of shares
authorized, issued and outstanding
• Decreased par value per share
• Balances in the accounts are unchanged
• Record in a memorandum entry
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9
E12-15
GENERAL JOURNAL
DATE
Jun
DESCRIPTION
REF
DEBIT
CREDIT
30 Called in the outstanding $1
par common stock and
distributed 2 shares of $0.50
par common stock for each old.
There are now 100,000 shares
outstanding.
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10
E12-3
Shares authorized and issued
Par value is cut in half
are double
Stockholders’ Equity:
Paid in Capital:
Common stock, $0.50 par, 400,000 shares
authorized, 100,000 shares issued
Paid in capital in excess of par
Total paid in capital
Retained earnings
Total stockholders’ equity
None of the amounts in the
accounts have changed
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$50,000
100,000
$150,000
200,000
$350,000
11
Objective 2
Distinguish stock splits from stock
dividends
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Comparison: Stock
Dividends & Stock Splits
Stock Dividend:
• Shifts amounts from
retained earnings to paidin capital
• Par value per share
remains unchanged
• Number of shares issued
increases
• Total stockholders’ equity
does not change
Stock Split:
• Account balances do not
change
• Par value decreases
• Number of shares of
stock authorized, issued,
and outstanding increase
• Total stockholders’ equity
does not change
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Objective 3
Account for treasury stock
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14
Treasury Stock
• Shares that a company has issued and
later reacquired
• Purchasing treasury stock decreases
assets and stockholders’ equity
• Contra equity account
• Record at cost
• Report after retained earnings on balance
sheet
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E12-17
GENERAL JOURNAL
DATE
Feb
Apr
DESCRIPTION
4 Cash
Common Stock
Paid in Capital in Excess of
Par, Common
22 Treasury Stock
Cash
REF
DEBIT
CREDIT
200,000
20,000
180,000
14,000
14,000
Contra Equity Account
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E12-17
GENERAL JOURNAL
DATE
DESCRIPTION
Aug 22 Cash
Treasury Stock
Paid in Capital from
Treasury Stock Transactions
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REF
DEBIT
CREDIT
12,000
8,400
3,600
17
E12-17
Common Stock
Paid in Capital
Paid in Capital
In Excess of Par,
from Treasury
Common
Stock Transactions
20,000
180,000
Retained Earnings
100,000*
3,600
Treasury Stock
14,000
8,400
5,600
*Assumed
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18
Austin Driving School, Inc.
Partial Balance Sheet
December 31, 2008
Stockholders’ Equity
Paid in Capital:
Common Stock
Paid in Capital in Excess of Par, Common
Paid in Capital from Treasury Stock
Transactions
Total Paid in Capital
Retained Earnings
Subtotal
Less Treasury Stock (400 shares at cost)
Total Stockholders’ Equity
$20,000
180,000
3,600
$203,600
100,000
$303,600
5,600
$298,000
*Assumed
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19
Shares Issued & Outstanding
• Issued shares – number of shares sold
• Outstanding shares – number of shares in
the hands of stockholders
• Treasury stock decreases the number of
shares outstanding
• Treasury stock does not receive dividends
In the previous example, then, the number of shares
issued are 20,000. The number of shares outstanding are
19,600 (20,000 – 400 shares in treasury)
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20
Retirement of Stock
• Decreases outstanding stock
• Retired shares cannot be reissued
• Remove stock from books
– Debit stock accounts
– Credit cash
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21
Objective 4
Report restrictions on retained
earnings
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22
Restrictions on Retained
Earnings
• Reported in notes to financial statements
• Restricts amount of retained earnings
available for dividends
• Appropriations are restrictions on retained
earnings recorded by formal journal
entries
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23
E12-19 a
Stockholders’ equity:
Common stock, no par
Retained earnings—Note X
Total stockholders’ equity
$50,000
250,000
$300,000
Note X— Long-term debt (or Restriction of
retained earnings). The company’s long-term
debt agreement restricts retained earnings in
the amount of $200,000.
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24
E12-19 b
Stockholders’ equity:
Total paid-in capital
Retained earnings:
Appropriated for debt agreement
Unappropriated
Total retained earnings
Total stockholders’ equity
$50,000
$100,000
150,000
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250,000
$300,000
25
Objective 5
Analyze a corporate income
statement
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26
Corporate Income Statement
Continuing Operations
Special Items
Earnings Per Share
Normal operating
revenues and expenses,
including income tax
expense
Items that are material in
amount, but are not
typical of regular
operations
Amount of net income for
each share of outstanding
common stock
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Income from Continuing
Operations
• Measures profitability of the ongoing
operations
• Useful for making projections about future
earnings
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28
Special Items
• Reported after income from continuing
operations
– Discontinued operations
– Extraordinary gains and losses
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Discontinued Operations
• Segment of a business that has been sold
• Two parts
– Income or loss from operations of business
from beginning of year to date of disposal
– Gain or loss on disposal of the assets of the
segment
– Reported net of the income tax effect
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30
Extraordinary Items
• Both unusual and infrequent
– Unusual in nature – abnormal and only
incidentally related to customary activities
– Infrequent in occurrence – not reasonably
expected to happen in the foreseeable future
• Reported net of income tax effect
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31
E12-20
Conner Photographic Supplies, Inc.
Income Statement
Year Ended December 31, 2008
Sales revenue
$430,000
Cost of goods sold
(240,000)
Gross profit
$190,000
Operating expenses
(120,000)
Income from continuing operations
$70,000
Loss on discontinued operations
$(50,000)
Income tax savings
20,000 (30,000)
Income before extraordinary items
$40,000
Extraordinary loss
$(15,000)
Income tax savings
6,000
(9,000)
Net income
$31,000
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Earnings Per Share
Net income - Preferred dividends
Average number of common shares outstanding
Report separate EPS figures for each line on income
statement starting with income from continuing
operations though to net income
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33
Earnings Per Share
and Preferred Stock
Corporations with complex capital structures
present two sets of EPS amounts
• Basic EPS
• Diluted EPS
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34
E12-21
Net income - Preferred dividends
Average number of common shares outstanding
=
=
$108,000 – (1,000 x 6% x $50)
(52,000 shares – 2,000 shares)
$105,000 / 50,000 shares
$2.10
Remember: Treasury stock is
not considered outstanding
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35
E12-22
Preferred dividends:10,000  $10  .05 = $5,000
Earnings per share:
Income from continuing operations
[($110,000 – $5,000) / 50,000]
Loss on discontinued operations ($8,000 / 50,000)
Income before extraordinary items
[($102,000 – $5,000) / 50,000]
Extraordinary gain ($20,000 / 50,000)
Net income [($122,000 – $5,000) / 50,000]
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$2.10
(.16)
$1.94
.40
$2.34
36
Statement of Retained Earnings
• Reports how retained earnings changed
over the accounting period
• Beginning balance + net income –
dividends = Ending balance
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Comprehensive Income
• Change in total stockholders’ equity from
all sources other than from its owners
– Net income
– Unrealized gains/losses on certain
investments
– Foreign currency translation adjustments
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Prior Period Adjustments
• Corrections to beginning balance of Retained
Earnings for errors of an earlier period
• Correcting entry includes
– Debit or credit to Retained Earnings for error amount
– Debit or credit to asset or liability account that was
misstated
• Reported on Statement of Retained Earnings
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39
E12-24
Sarah Lou Bakery, Inc.
Statement of Retained Earnings
Year Ended December 31, 2003
Millions
Retained earnings, December 31, 2002,
as originally reported
Prior period adjustment
Retained earnings, December 31, 2002,
as adjusted
Net income for 2003
Subtotal
Dividends for 2003
Retained earnings, December 31, 2003
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$39,000
(5,000)
34,000
70,000
104,000
(24,000)
$80,000
40
End of Chapter 12
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41