INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by
Gabriela H. Schneider, CMA; Grant MacEwan College
CHAPTER
17
Shareholders’ Equity:
Retained Earnings
Learning Objectives
1. Describe the policies used in distributing dividends.
2. Identify the various forms of dividend distributions.
3. Explain the accounting for stock dividends.
4. Distinguish between stock dividends and stock
splits.
5. Explain the effect of different types of preferred
stock dividends.
Learning Objectives
6. Identify the reasons for appropriating retained
earnings.
7. Explain accounting and reporting for appropriated
retained earnings.
8. Indicate how shareholders’ equity is presented
and analysed.
Shareholders’ Equity:
Retained Earnings
Retained
Earnings
Dividend
Policy
Legality of dividends
Financial condition
and dividend
distributions
Types of dividends
Stock split
Effect of dividend
preferences
Presentation
Appropriation
of Retained and Analysis of
Shareholders’
Earnings
Equity
Recording
appropriations
Disclosure of
restrictions
Trends in
terminology
Presentation
Analysis
Retained Earnings
Represents the accumulated increase in net assets from
profits generated (or decrease when a loss exists), net
of distributions to shareholders in the form of dividends.
Most common items posted through Retained Earnings
Net loss
Retroactive adjustments
from changes in accounting
principles or error
corrections
Cash, or scrip dividends
Stock dividends
Property dividends
Some treasury stock
transactions
Net income
Retroactive adjustments
from changes in accounting
principles or error
corrections
Adjustments due to
financial reorganization
Dividend Policy
• Earnings not retained by the corporation for reinvestment
in the operations of the business are distributed to
shareholders as dividends
• Not all retained earnings are paid out as dividends, not
due to contractual obligations but for management
reasons such as:
• Lack of cash
• Agreements with creditors to retain earnings to provide
protection for the creditors
• To internally finance growth or expansion (referred to as
internal financings or “plowing” profits back into the business)
• To smooth our dividend payments over a period of time
• To provide a cushion against possible losses
• Legal restrictions
Legality of Dividends
•
Two questions need to be answered
when considering the declaration of
dividends:
1. Is the corporation in a position where a
dividend is legally permissible?
2. Is the corporation in a position where a
dividend is economically sound?
Legality of Dividends
• Retained Earnings has a sufficient balance, taking into
consideration any legal restrictions on the balance
• The corporation will not be made insolvent as a result of
the dividends
• Liabilities due in the upcoming year can be made
• Realizable value of the assets will not be less than the total
liabilities + stated capital
• Deficits must be eliminated before the payment of any
dividends
• The dividends do not reduce Retained Earnings below the
cost of any Treasury Shares (this provision exists in most
jurisdictions)
Types of Dividends
•
•
•
•
•
Cash Dividends
Property Dividends
Scrip Dividends
Liquidating Dividends
Stock Dividends
Dividend Effect on the Balance Sheet
Declaration Date
Cash Dividend
Property Dividend
Scrip Dividend
Stock Dividend
Payment or Distribution Date
Increase Liabilities
Decrease Liabilities
Decrease Equity
Decrease Cash
Increase Liabilities
Decrease Liabilities
Decrease Equity
Decrease Assets
Increase Liabilities
Decrease Liabilities
Decrease Equity
Decrease Cash
No net effect on
Equity
Increase Share Capital
Decrease Retained Earnings
Net Effect - None
Cash Dividends:
Important Dates
•
There are three important dates:
• the declaration date (dividends are declared
and accrued)
• the date of record (list of stockholders to
whom dividends are to be paid is finalized)
• the payment date (dividends are paid to
stockholders of record)
•
Dividend becomes a current liability
on the declaration date
Cash Dividends: Journal Entries
Date Declared
Retained Earnings
Dividends Payable
Date of Record
No Entry
Date of Payment
Dividends Payable
Cash
Cash Dividends
• Par value share dividends are often expressed as
a percentage of the par value amount
• Cash dividends declared on preferred shares are
in substance financial liabilities; those dividends
are treated as interest on long-term debt
• Dividends are declared only on issued and
outstanding shares
• Treasury shares, cancelled/retired shares or
subscribed shares not fully paid for do not receive
dividends
Property Dividends
• When assets other than cash are distributed to
shareholders as a dividend (dividend in kind)
• Distribution of investment securities is the usual
form
• Are a nonreciprocal transfer of nonmonetary
assets between an enterprise and its owners
• Nonreciprocal transfer: a transfer of assets or
services in one direction … without consideration
Property Dividends
• Recorded at the fair value of the asset
given up (except in spin-offs and
reorganizations)
• Corporation recognizes gain/loss on the
distribution (except in spin-offs and
reorganizations)
Property Dividends
On declaration date the following entries are made:
Asset
Dr. if FMV > BV
Cr. If FMV < BV
Gain/Loss on Appreciation of Assets
Property Dividend Declared
Amt. of Dividend
Property Dividend Payable
Amt. of Dividend
On Distribution Date
Property Dividend Payable
Asset
$$$$
$$$$
Property Dividends: Entries
Given:
• Company distributes certain marketable
securities to shareholders
• Dividend is declared on Dec 28, 2001 and is
distributable on Jan 30, 2002 to shareholders of
record on Jan 15, 2002
• Cost of securities Dec 28, 2001 = $1,250,000
Fair value of securities Dec 28, 2001 =
$2,000,000
Provide the journal entries on the dates of
declaration, record, and payment.
Property Dividends: Entries
1 Declaration Date
Investments
750,000
Gain on Apprec.
750,000
2 Declaration Date
Retained Earnings
Prop. Div. Pay.
2,000,000
2,000,000
3 Payment Date
Prop. Div. Pay
Investments
2,000,000
2,000,000
Scrip Dividends
• Dividend is payable at some future date,
•
•
•
•
but is accrued now
Scrip dividend is a special form of note
payable
Recipient of scrip can hold it or sell it
Interest is paid on scrip until dividend is
paid at a later date
Such payment is interest, not dividend
Scrip Dividends: Entries
Given:
• Scrip dividend is declared on 2,545,000
shares at $0.80 per share on May 27
• Notes payable is issued for dividends
payable on July 27
• Interest is payable at 10%
Provide the journal entries on the
declaration and payment dates.
Scrip Dividends: Entries
Declaration Date
May 27
Retained Earnings 2,036,000
Notes Payable
2,036,000
($.80 * 2,545,000)
Payment Date
July 27
Notes Payable
2,036,000
Interest Expense
33,933
Cash
2,036,000
(2,036,000 * 2/12 * .10)
Liquidating Dividends
• When the total dividend declared is greater than
the balance of retained earnings
• Liquidating dividend = Retained Earnings + an
amount from Contributed Surplus
• A liquidating dividend should be clearly disclosed
to shareholders; this type of dividend is returning
a portion of their investment, rather than a
simple return on investment
• Note that the journal entry on declaration date
includes a debit to Contributed Surplus
Stock Dividends
• Dividend is paid in the form of additional
shares
• Shareholders maintain their proportionate
ownership of the corporation
• Corporation retains cash (or other assets)
while maintaining dividends
• May have an effect on the market value of
the share, but only if the stock dividend is
a large one
Stock Dividends
• Book value of each share is decreased due to
the increased number of outstanding shares
• Shareholders individual total book value
remains the same
• The FMV = market price of the share on the
date of declaration is used to determine the
value of the stock dividend
• No liability is created when the stock dividend
is declared
• The accounts which form the journal entry on
declaration date are equity accounts
Stock Dividends
Given:
A company currently has 1,000 common shares
outstanding
Retained Earnings = $50,000
December 15, 2000 the Board of Directors declares a 10
percent stock dividend distributable on January 2, 2001 to
all shareholders of record on December 27, 2000
The market value of the shares on December 15 is
$130.00
What is the significance of the three dates which are
underlined in the information given?
Stock Dividends
Stock dividend = 10% of 1,000 shares = 100 shares
Fair Value = 100 * $130.00 = $130,000
Declaration
Date
Retained Earnings
13,000
Common Stock
Dividend Distributable
13,000
Distribution
Date
Common Stock
Dividend Distributable 13,000
Common stock
13,000
Stock Splits
• Motive is to manipulate market value of the
shares
• A stock split will reduce the market value by
increasing the number of shares outstanding
• A reverse stock split increases the market value
by decreasing the number of shares outstanding
• The shareholders’ proportionate ownership
remains the same after the stock split
• No journal entry required for a stock split
• Memo entry created to indicate the change in
the number of shares issued and outstanding
Stock Dividend vs. Stock Split
Stock dividend
• Increase in the share
capital account, decrease in
the retained earnings
account
• Net change to
shareholders’ equity is nil
• The number of outstanding
shares increases
Stock split
• No change in the
share capital or
retained earnings
accounts
• Only change is the
number of shares
outstanding
If the Board of Directors should declare a stock dividend of
25 percent or more, this is deemed to be a stock split and
should be accounted for in that manner.
Preferred Stock Dividends
Participating
Cumulative
Non-Participating
Participating
Non-Cumulative
Non-Participating
Preferred Stock Dividends
Given:
• $50,000 to be distributed as cash dividends
• Common shares share capital $400,000
• Preferred shares outstanding
• 1,000 shares
• Share capital value $100,000
• Stated dividend $6.00 per share
• Dividends have not been declared for the
previous 2 years
Non-Cumulative, Non-Participating
With non-cumulative
shares no distribution
of dividends in arrears
is required
Preferred share dividends
are calculated and paid
before common share
dividends
Preferred Common
1000 * $6.00
Balance to
Common
Totals
$6,000
Total
$6,000
$44,000
44,000
$6,000 $44,000
$50,000
Cumulative, Non-Participating
Preferred share dividend
arrears are calculated and
paid before any other
dividends
Preferred Common
Dividends in arrears
1000 * $6.00 * 2 years
1000 * $6.00
Balance to Common
Totals
Total
$12,000
$12,000
6,000
$6,000
$32,000
32,000
$18,000 $32,000
$50,000
Participating Preferred
•
Calculation steps:
1. Pay out the “regular” preferred dividends
(including any arrears)
2. Pay out to the common shareholders an
amount equal to the “return rate” earned
by the preferred shareholders
3. The balance is then available for
participation by preferred shareholders
•
•
Shared by both preferred and common
Participation is based on pro-rata share of
share capital
Non-Cumulative, Participating
Preferred
1000 * $6.00
$6,000
‘Like’ amount paid to common
$400,000 * 6%
Balance available for participation
Preferred = 4.0% * $100,000
Common = 4.0% * $400,000
Totals
Common
Total
$6,000
$24,000
24,000
4,000
16,000
20,000
$10,000
$40,000
$50,000
Rate of return earned by preferred = Current Dividend  Share Capital
= $6,000  $100,000 = 6%
This rate of return is paid to the common shareholders prior to the participation
dividend being paid out.
Participation rate = (Balance of dividends  Total Share Capital)
=(50,000-[6,000+24,000])  (100,000+400,000) = 4.0%
Each share category then receives an amount = Rate * Share Capital
Cumulative, Participating
Preferred Common
Dividends in arrears: 1000 * $6.00 * 2
1000 * $6.00
Total
$12,000
$12,000
$6,000
$6,000
“Like” amount paid to common
$400,000 * 6% (Note this calculation does
$24,000
24,000
not change with cumulative!)
Total to be paid out prior to participation
Balance available for participation
Participation Rate =
$8,000  $500,000 = 1.6%
Preferred = 1.6% * $100,000
Common = 1.6% * $400,000
Totals
42,000
4,000
$10,000
16,000
8,000
$40,000 $50,000
Appropriation of
Retained Earnings
• Reclassification of Retained Earnings for a
specific purpose
• Retained Earnings which are restricted
cannot be distributed as dividends
• Retained Earnings (unappropriated) is
debited by the amount of the
appropriation
• A separate Retained Earnings account is
established for each specific purpose
Appropriation of
Retained Earnings
• Appropriations arise from:
• Statutory or contractual obligations
• Discretionary action by management and the
Board of Directors
• Possible or expected losses
• Protection of working capital
• Neither the appropriation nor the return to unappropriated Retained Earnings has no effect on total
Shareholders’ Equity
• CICA Handbook recommends the use of the term
reserves is limited to appropriations of retained
earnings or other surplus
Reporting from Appropriations
• Retained Earnings restrictions, whether legal or
discretionary, are disclosed by a note to the
financial statements, and most often include
the following information:
• Source of the restriction
• Relevant provisions
• Amount of retained earnings
restricted, or not restricted
Cumulative Translation
Adjustments
• Relates to self-sustaining foreign subsidiaries
• When the amounts related to these subsidiaries are carried
on the controlling corporations financial statement, they
are carried at the current Canadian dollar amount
• This exchange rate changes from period to period
• The translation difference, from period to period, is
charged or credited to a Cumulative Translation Adjustment
account
• This account is part of the Shareholders’ Equity section of
the balance sheet
• If there are significant exchange gains/losses in a period
this is disclosed in the notes to the statements
Reporting Shareholders’ Equity
• CICA Handbook, Section 3250 recommends
that the following information be disclosed
•
•
•
•
Changes in each Contributed Surplus source
Changes in Retained Earnings
Changes in Retained Earnings Appropriations
Changes in Share Capital (CICA Handbook,
Section 3240)
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