Accounting
Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
Carole Bowman, Sheridan College
Julia Banks, Cairine Wilson
CHAPTER
14
CORPORATIONS:
DIVIDENDS,
RETAINED EARNINGS,
AND INCOME REPORTING
DIVIDENDS
•
•
A dividend is a distribution of a portion of a corporation’s
earnings to its shareholders on a pro rata (equal) basis.
Dividends may be in the form of
– Cash
– Shares (normally common shares)
•
Expressed in two ways:
1. as a $ amount per share
2. as a percentage of the stated or par
value of the shares
•
•
Generally reported quarterly as a dollar amount per share
Sometimes expressed as a % where dividend rate is calculated by
multiplying the rate by the legal capital to determine annual
dividend rate.
Example: 8% preferred dividend with a stated value of $100
would have an annual dividend of $8 per share
•
Generally declared and paid out quarterly
CASH DIVIDEND$
• A cash dividend is a pro rata (equal)
distribution of cash to shareholders.
• For a cash dividend to occur, a
corporation must have:
1. Sufficient retained earnings,
2. Adequate cash, and
3. Declared dividends by the BOD.
They are not a liability until declared.
ENTRIES FOR CASH DIVIDENDS
• Three dates are important in connection
with dividends:
– Declaration date
– Record date
– Payment date
• Normally 2-4 weeks in between dates
• Accounting entries made on declaration
date and payment date.
Entries For Cash Dividends Cont’…
Declaration Date
• BOD commits the corporation to a legal obligation. It is
binding and cannot be reversed.
• Usually paid within a month of declaration.
Journal Entry
On Dec. 1, 2003, the directors of Media General declare a $.50 per share
cash dividend on 100,000 common shares.
Dec. 1 Cash Dividends – Common
50,000
Dividends Payable
To record declaration of cash dividend.
50,000
Note: Cash Dividends account is like a “drawings account.” It will be
closed out to the retained earnings account and will decrease it. Some
companies debit the retained earnings account directly.
Entries For Dividends
Declaration Date  Record Date
• Corporation updates its share ownership records and
determines the ownership of the shares
Payment Date
• Dividend cheques are mailed to shareholders and the payment
of the dividend is recoreded.
Journal Entry
On Jan. 20 dividend cheques totally $50,000 are mailed out.
Jan. 20 Dividends Payable
50,000
Cash
To record payment of cash dividend
50,000
ALLOCATING CASH DIVIDENDS
BETWEEN PREFERRED AND COMMON
SHARES
• Cash dividends must first be paid to preferred
shareholders before any common shareholders are
paid.
• When preferred shares are cumulative, any
dividends in arrears must be paid to preferred
shareholders before allocating any dividends to
common shareholders.
• When preferred shares are non-cumulative, only the
current year’s dividend must be paid to preferred
shareholders before paying any dividends to
common shareholders.
Journal Entry Examples
At December 31, 2003, IBR Inc. has 1,000 $8 cumulative preferred shares. It also has
50,000 common shares. At December 31, 2003, the directors declare a $6,000 cash
dividend. The required annual preferred dividend is $8,000. (1,000 x $8). In this case,
the entire $6,000 dividend goes to preferred shareholders.
Dec. 31
Cash Dividends – Preferred
6,000
Dividends Payable
To record partial cash dividend to preferred shareholdes
6,000
Note: This declaration results in a $2 per share dividends in arrears.
If at December 31, 2004, IBR declares a $50,000 cash dividend the entry would be:
Dec. 31
Notes:
Cash Dividend – Preferred
Cash Dividend – Common
Dividends Payable
To record declaration of cash dividends.
Total Dividend: $50,000
Preferred Dividends in arrears from 2003 (1,000 x $2)
2004 Preferred Dividend (1,000 x $8)
Remainder to common shares
10,000
40,000
50,000
$2,000
8,000
40,000
$50,000
STOCK DIVIDENDS
• A stock dividend is a pro rata (equal) distribution of
the corporation’s own shares to its shareholders.
• A stock dividend results in a decrease in retained
earnings and an increase in share capital since a
portion of retained earnings is transferred to legal
capital.
• In most cases, the fair market value is assigned to
the dividend shares.
• Total shareholders’ equity and the legal capital per
share remain the same. There is no change in
assets either.
Stock Dividends
Stock dividend results in the ownership of more
shares, but the ownership interest reamins the
same for the shareholder.
Example:
Assume you have 2% ownership in IBR Inc.
You own 1,000 of its 50,000 common shares. If
IBR declares a 10% stock dividend it would
issue 5,000 shares. (50,000 x 10%).
• You would receive 2% of the 5,000 shares
which is equal to 100 shares.
• Your ownership remains at 2% (1,100 /
55,000)
PURPOSES AND BENEFITS OF
STOCK DIVIDENDS
• For company
– To satisfy shareholders' dividend expectations
without spending cash
– To increase marketability of its shares by
increasing number of shares and decreasing
market price per share
– To reinvest and restrict a portion of shareholders'
equity
PURPOSES AND BENEFITS OF
STOCK DIVIDENDS
• For shareholder
– More shares with which to earn additional
dividend income
– More shares for future profitable resale, as
share price climbs again
Stock Dividend Journal Entries
Medland Corporation has a blance of $300,000 in retained earnings. On June
30, 2003, it declares a 10% stock dividend on its 50,000 no par value
common shares. The current fair market value of its shares is $15 per
share.
• The number of shares to be issued is 5,000 (10% of 50,000).
• The total amount to be debited to Stock dividends account is $75,000
(5,000 x $15).
• The journal entry would be:
June 30
Stock Dividends – Common
75,000
Common Stock Dividends Distributable
To record declaration of 10% stock dividend.
75,000
Note: If common shares had a stated value of $10, the entry would be as
follows:
June 30
Stock Dividends – Common
75,000
Common Stock Dividends Distributable
Contributed Capital in Excess of CS Div. Distributable
To record declaration of 10% stock dividend.
50,000
25,000
Stock Dividends and the Balance Sheet
____________________________________________________________________________________________________
Medland Corporation
Balance Sheet (partial)
June 30, 2003
Shareholder’s Equity
Share capital
Common Shares
Common Stock Dividends Distributable
Retained Earnings
Total Shareholder’s Equity
$500,000
75,000
$575,000
225,000
$800,000
_____________________________________________________________________________________________________
Note: Common Stock Dividends Distributable is a Shareholder’s Equity account. Is is not
a liability, because assets are not being used to pay the dividend.
Once the dividends are issued the journal entry would be when there is no stated value:
Aug. 5
Common Stock Dividends Distributable
Common Shares
To record the issue of 5,000 shares in stock dividend.
75,000
75,000
ILLUSTRATION 15-4
STOCK DIVIDEND EFFECTS
Shareholders’ equity
Common shares
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
Before
Stock Dividend
After
Stock Dividend
$500,000
300,000
$800,000
50,000
$ 16.00
$575,000
225,000
$800,000
55,000
$ 14.55
• Stock dividends change the composition of shareholders’
equity because a portion of retained earnings is
transferred to contributed capital.
• However, total shareholders’ equity remains the same.
The number of shares increases and this means that the
book value per share decreases.
STOCK SPLITS
• A stock split involves the issue of additional shares to
shareholders according to their percentage of ownership.
• In a stock split, the number of shares is increased in the
same proportion that legal capital per share is decreased.
• A stock split has no effect on total share (contributed)
capital, retained earnings, or shareholders’ equity.
• Purpose of a stock split is to increase the marketability of
the shares by lowering the market value per share.
– Increases investor interest
STOCK SPLIT EFFECTS
A stock split does not affect total share capital, retained
earnings, or shareholders’ equity. However:
1. the number of shares increases; and
2. book value per share decreases.
Since a stock split does not affect any account balances,
it is not necessary to record a journal entry. A memo
noting the details would be added to any financial reports.
Example of a Stock Split of 2 for 1.Before
Stock Split
Shareholders’ equity
$500,000
Common shares
300,000
Retained earnings
$800,000
Total shareholders’ equity
50,000
Issued shares
$ 16.00
Book value per share
After
Stock Split
$500,000
300,000
$800,000
100,000
$
8.00
EFFECTS OF STOCK SPLITS, STOCK
DIVIDENDS, AND CASH DIVIDENDS
Stock
Split
Total assets
Total liabilities
Total shareholders’ equity
Total share capital
Total retained earnings
Legal capital per share
Book value per share
Number of shares
% of shareholder ownership
NE = No effect
NE
NE
NE
NE
NE



NE
 = Increase
Stock
Dividend
NE
NE
NE


NE


NE
Cash
Dividend

NE

NE

NE

NE
NE
 = Decrease
RETAINED EARNINGS
• Retained earnings is the cumulative net
earnings (less losses) and less declared
dividends.
Retained Earnings, Opening balance
+ Annual Net earnings (or - net loss)
- Dividends
= Retained earnings, Ending balance
DEFICIT
Shareholders’ equity
Share capital
Common shares
Retained earnings (deficit)
Total shareholders’ equity
$800,000
(50,000)
$750,000
A debit balance in retained earnings is identified
as a DEFICIT and is reported as a deduction in
the shareholders’ equity section
RETAINED EARNINGS RESTRICTIONS
• In some cases there may be retained earnings
restrictions that make a portion of the balance
currently unavailable for dividends
• Restrictions result from one or more of the
following causes
– Legal
– Contractual (i.e. long-term debt contract)
– Voluntary (BOD may have plans for future expansion
operations that will require more cash
availability)
PRIOR PERIOD ADJUSTMENTS
• A prior period adjustment results from
1. the correction of a material error in
reporting net income in previously
issued financial statements, or
2. changing an accounting principle.
PRIOR PERIOD ADJUSTMENTS
• A correction of an error occurs after the books
are closed, and relates to a prior accounting
period.
• A change in an accounting principle occurs when
the principle used in the current year is different
from the one used in
the preceding
year.
(i.e. change inventory valuation method or change
the method of amortization)
Accounting for a Prior Period Error
•
•
•
•
General Microwave Corp. discovers in 2003 that it overstated its cost of goods sold
in 2002 by $30,000.
This error overstates expenses which understates income before and after tax.
If the income tax rate is 45% and net income before tax was overstated by $30,000.
Then income tax would be understated by $13,500. ($30,000 x .45).
The overall impact on the final net income would be an understatement of $16,500
($30,000 - $13,500).
Impact…Merchandise Inventory is understated, the company owes more
tax and its retained earnings will be understated.
The correcting journal entry would be:
Dec. 31
Merchandise Inventory
30,000
Income Tax Payable
Retained Earnings
To adjust for overstatement of cost of goods sold in
a prior period.
13,500
16,500
PRIOR PERIOD ADJUSTMENTS
• The cumulative effect of the correction or
change (net of income tax) should be
– Made directly to Retained Earnings;
– Reported in the current year’s Retained
Earnings Statement as an adjustment of the
beginning balance of Retained Earnings; (see
next slide)
– Disclosed in a footnote to the financial
statements;
– Corrected and restated in all prior period
financial statements presented; and
– The corrected amount or new principle should
be used in reporting the results of operations
of the current year.
Statement of Retained Earnings
Correcting Prior Period Error
______________________________________________________________
General Microwave Corp.
Statement of Retained Earnings (partial)
For the Year Ended December 31, 2003
Balance, January 1, 2003, as previously reported
Add: Correction for overstatement of cost of goods sold
in 2002, net of income tax expense of 413,500
Balance, January 1, 2003 as adjusted
$800,000
16,500
$816,500
______________________________________________________________
Corrections are not made to current year’s income statements because
they apply to prior year’s income. Thus retained earnings is
impacted directly to correct prior errors.
Accounting for a Change in Accounting
Principles or Policies
At the beginning of 2003, St. Onge Limited changes from the straight-line
method of amortization to the declining-balance method for equipment.
Assume that the impact of this change caused an increase in amortization
expense of $24,000.
This expense would decrease income before tax by $24,000.
If the income tax rate was 30% the after-tax effect would be a tax reimbursement
of $16,800. [24,000 x (100% - 30%)]
The journal entry to correct this change would be:
Dec. 31
Income Tax Payable (or Recoverable)
16 800
Retained Earnings
7200
Accumulated Amortization
24,000
To record retroactive effect on capital assets of change
in amortization method.
Statement of Retained Earnings Correcting
Prior Period Error
____________________________________________________________
St. Onge Limited
Statement of Retained Earnings (partial)
For the Year Ended December 31, 2003
Balance, January 1, 2003, as previously reported $500,000
Less: Cumulative effect of change in amortization method, net
of $7,200 income tax savings
Balance, January 1, 2003, as adjusted
(16,800)
$ 483,000
____________________________________________________________
See pg. 702 & 703 of your text for examples of statement format.
DEBITS AND CREDITS TO RETAINED EARNINGS
Retained Earnings
1.
2.
3.
4.
5.
Debits (Decreases)
Correction of a prior period
error that overstated income
Cumulative effect of a
change in accounting
principle that decreased
income
Net loss
Cash dividends
Stock dividends
Credits (Increases)
1. Correction of a prior period
error that understated
income
2. Cumulative effect of a
change in accounting
principle that increased
income
3. Net income
Many corporations prepare a statement of retained
earnings to explain the changes in retained earnings
during the year. Some companies combine this statement
of retained earnings with their income statement.
CORPORATION INCOME STATEMENTS
• Useful for evaluating performance of managers and
estimate future cash flows
• The income statement for a corporation includes
essentially the same sections as in a proprietorship or
a partnership.
• The major difference is a section for income tax
expense.
• For tax purposes, corporations are considered to be a
separate legal entity.
INCOME STATEMENT WITH INCOME TAX
LEADS INC.
Income Statement
For the Year Ended December 31, 2003
Sales
$800,000
Cost of goods sold
600,000
Gross profit
200,000
50,000
Operating expenses
150,000
Income from operations
10,000
Other revenues and gains
4,000
Other expenses and losses
156,000
Income before income tax
46,800
Income tax expense
$109,200
Net Income
Accounting For Income Tax
•
•
•
•
Income tax is calculated annually, but must be estimated and remitted
monthly.
Thus, the year-end current liability for Taxes Payable is usually much
less than the income tax reported on the income statement.
Most companies have 2-3 months after year end to remit any unpaid
taxes without penalty.
Companies have 6 months after their fiscal year end to file their
completed income tax return.
Assume, Leads Inc. had estimated its income tax would total $42,000. It
remitted monthly instalments to Canada Customs and Revenue
Agency in the amount of $3,500 a month. At year end, Leads
calculated it had owed $46,800 in income tax.
What would be the year end adjustment to record taxes still owed to
the government? $46,800 – (3,500 x 12)
Dec. 31
Income Tax Expense
4,800
Income Tax Payable
4,800
To adjust estimated income tax expense to actual.
INTRAPERIOD TAX ALLOCATION
• Intraperiod tax allocation refers to the procedure of
associating income taxes within the fiscal period the
income statement covers. (Based on GAAP principles)
• In contrast, interperiod tax allocation allocates income
taxes between two or more periods. (Based on CCRA
rules)
• Under intraperiod tax allocation, the income tax expense
or tax saving is shown after the “Income before tax” and
before the final “Net Income/Loss” portion of the Income
Statement.
• Each non-typical item discussed next is also shown net
of tax.
ADDITIONAL SECTIONS OF AN
INCOME STATEMENT
• Additional sections should be added to the
income statement to report material items
not typical of regular operations.
• These non-typical times include:
1. Discontinued operations
2. Extraordinary items
• Each item should be carefully explained in notes
to the financial statements, and the income
statement should report the income tax expense
or savings applicable to each item.
STATEMENT PRESENTATION OF
DISCONTINUED OPERATIONS
HWA ENERGY INC.
Income before income tax
Income tax expense
Income from continuing operations
Discontinued operations
Loss from operations of chemical division,
net of $60,000 income tax saving
Loss from disposal of chemical division,
net of $30,000 income tax saving
Net income
$800,000
240,000
560,000
$140,000
70,000
210,000
$350,000
Note that the caption “Income from continuing operations” is
used and that a section “Discontinued operations” is added.
Within the new section, both the operating loss and the loss on
disposal are reported net of applicable income tax.
DISCONTINUED OPERATIONS
• Discontinued operations refers to the disposal of a
significant segment of a business, such as the
elimination of an entire activity or of a major class of
customers.
• Income statement reports both income (loss) from
continuing operations and income (loss) from
discontinued operations.
• Income (loss) from discontinued operations consists
of 1) income (loss) from operations and 2) gain (loss)
on disposal of the segment.
• Both components are reported net of applicable
income tax in a section entitled Discontinued
Operations, which follows Income from Continuing
Operations.
EXTRAORDINARY ITEMS
• Extraordinary items are events and
transactions that meet three conditions:
– Infrequent
– Non-typical
– Not subject to management decision
• Extraordinary items are reported net of
income tax in a separate section of the income
statement immediately following discontinued
operations.
ILLUSTRATION 15-18
STATEMENT PRESENTATION OF
EXTRAORDINARY ITEMS
HWA ENERGY INC.
Income Statement (partial)
For the Year Ended December 31, 2003
Income before income tax
Income tax expense
Income from continuing operations
Discontinued operations
Loss from operations of chemical division, net
of $60,000 income tax saving
Loss from disposal of chemical division, net of
$30,000 income tax saving
Income before extraordinary item
$800,000
240,000
560,000
$140,000
70,000
Extraordinary item
Expropriation of property, net of $21,000 income tax saving
Net income
210,000
350,000
49,000
$301,000
EXAMPLES OF
EXTRAORDINARY AND ORDINARY
ITEMS
Extraordinary Items
Ordinary Items
1. Effects of major
casualties (acts of God) if
rare in the area
2. Expropriation
(takeover) of property by
a government
3. Effects of a newly
enacted law or regulation,
such as a condemnation
action
1. Effects of major
casualties (acts of God) if
frequent in the area
2. Write down of
inventories or write off of
receivables
3. Losses attributable to
labour disputes
4. Gains or losses from
sale of capital assets
EARNINGS PER SHARE
•
Earnings per share (EPS) indicates the net income earned by each
common share.
•
Companies report earnings per share on the income statement
•
Information is used by shareholders and potential investors in
evaluating the profitability of a company. EPS is required for
publicly held companies and recommended for private companies.
•
When a company has both preferred and common shares, the current
year’s dividend on preferred shares is subtracted from the net income
to determine the EPS on common shares.
•
The formula to calculate earnings per share when there has been no
change in shares during the year is as follows:
Net Income –
Preferred Dividends

Number of
Common Shares
Earnings per
Share
ADDITIONAL EARNINGS PER SHARE
DISCLOSURES
HWA ENERGY, INC.
Net income
Earnings per share
Income from continuing operations
Loss from discontinued operations
Income before extraordinary item
Extraordinary loss
Net income
$301,000
$5.60
(2.10)
3.50
(.49)
$3.01
When the income statement contains any non-typical item,
EPS should be disclosed for each component.
PRICE - EARNINGS RATIO
The price-earnings (P/E) ratio helps investors determine
whether the shares are a good investment in relation to
earnings. It is a per share calculation, calculated by dividing
the market price of the shares by its earnings per share.
Market price
per share

Earnings
per share
Price-Earnings
Ratio
A high P/E ratio can be one indicator that investors believe the
company has future growth potential.
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