14-1 corporations: dividends, retained earnings, and income reporting 14 learning objectives explain...

14-1

Corporations: Dividends, Retained Earnings, and Income Reporting14

Learning Objectives

Explain how to account for cash dividends.

Explain how to account for stock dividends and splits.

Prepare and analyze a comprehensive stockholders’ equity section.

3

2

1

Describe the form and content of corporation income statements.

4

14-2

Distribution of cash or stock to stockholders on a pro rata

(proportional to ownership) basis.

Types of Dividends:

1. Cash dividends.

2. Property dividends.

Dividends are generally reported quarterly as a dollar amount

per share.

3. Stock dividends.

4. Scrip (promissory note).

LO 1

LEARNINGOBJECTIVE

Explain how to account for cash dividends.

1

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For a corporation to pay a cash dividend, it must have:

1. Retained earnings - Payment of cash dividends from

retained earnings is legal in all states.

2. Adequate cash.

3. A declaration of dividends by the Board of Directors.

Cash Dividends

LO 1

14-4

Three dates are important: Illustration 14-1Key dividend dates

LO 1

Cash Dividends

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Illustration: On Dec. 1, the directors of Media General declare a 50

cents per share cash dividend on 100,000 shares of $10 par value

common stock. The dividend is payable on Jan. 20 to shareholders of

record on Dec. 22.

Dec. 1 (Declaration Date)

Cash Dividends 50,000

Dividends Payable 50,000

Dec. 22 (Date of Record)

Jan. 20 (Payment Date)


Cash 50,000

No entry

LO 1

Cash Dividends

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Right to receive dividends before common stockholders.

Per share dividend amount is stated as a percentage of

the preferred stock’s par value or as a specified amount.

Cumulative Dividend

Preferred stockholders must be

paid both current-year

dividends and any unpaid prior-

year dividends before common

stockholders receive dividends.

Dividend Preferences

LO 1

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CUMULATIVE DIVIDEND

Illustration: Scientific Leasing has 5,000 shares of 7%, $100 par

value, cumulative preferred stock outstanding. Each $100 share

pays a $7 dividend (.07 x $100). The annual dividend is $35,000

(5,000 x $7 per share). If dividends are two years in arrears,

preferred stockholders are entitled to receive the following

dividends in the current year.Illustration 14-2Computation of total dividends to preferred stock

Advance slide in slide show to reveal dividend amounts. LO 1


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ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON STOCK

Holders of cumulative preferred stock must be paid any

unpaid prior-year dividends and their current year’s dividend

before common stockholders receive dividends.

LO 1


14-9

Illustration: On December 31, 2017, IBR Inc. has 1,000 shares

of 8%, $100 par value cumulative preferred stock. It also has

50,000 shares of $10 par value common stock outstanding. At

December 31, 2017, the directors declare a $6,000 cash dividend.

Prepare the entry to record the declaration of the dividend.



Preferred Dividends: 1,000 shares x $100 par x 8% = $8,000

ALLOCATING CASH DIVIDENDS

LO 1

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2017 2018

Dividends declared 6,000$

Dividends in arrears

Allocation to preferred 6,000

Remainder to common -$

* 1,000 shares x $100 par x 8% = $8,000

*

** 2017 Pfd. dividends $8,000 – declared $6,000 = $2,000

**

Illustration: At December 31, 2018, IBR declares a $50,000

cash dividend. Show the allocation of dividends to each class of

stock.

$ 50,000

2,000

8,000

$ 40,000

LO 1


14-11

Illustration: At December 31, 2018, IBR declares a $50,000 cash

dividend. Prepare the entry to record the declaration of the

dividend.



LO 1


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Preferred stockholders are paid only this year’s dividend.

Preferred stockholders = $12,000 (2,000 x .06 x $100).

Common stockholders = $48,000 ($60,000 - $12,000).

LO 1

DO IT! Dividends on Preferred and Common Stock1

MasterMind Corporation has 2,000 shares of 6%, $100 par value

preferred stock outstanding at December 31, 2017. At December 31,

2017, the company declared a $60,000 cash dividend. Determine the

dividend paid to preferred stockholders and common stockholders

under each of the following scenarios.

1. The preferred stock is noncumulative, and the company has

not missed any dividends in previous years.

Solution

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Past unpaid dividends do not have to be paid.

Preferred stockholders = $12,000 (2,000 x .06 x $100).


LO 1






2. The preferred stock is noncumulative, and the company did

not pay a dividend in each of the two previous years.

Solution


14-14

Dividends that have been missed (dividends in arrears) must be paid.

Preferred stockholders = $36,000 (3 x 2,000 x .06 x $100).


LO 1






3. The preferred stock is cumulative, and the company did not

pay a dividend in each of the two previous years.

Solution


14-15

A pro rata (proportional to ownership) distribution of the

corporation’s own stock to stockholders.

Reasons why corporations issue stock dividends:

1. Satisfy stockholders’ dividend expectations without

spending cash.

2. Increase marketability of the corporation’s stock.

3. Emphasize a portion of stockholders’ equity has been

permanently reinvested in the business.

Stock Dividends

LO 2

LEARNINGOBJECTIVE

Explain how to account for stock dividends and splits.

2

14-16

Small stock dividend (less than 20–25% of the

corporation’s issued stock, recorded at fair market value)

Large stock dividend (greater than 20–25% of issued

stock, recorded at par value)

* Accounting based on the assumption that a small stock dividend will have little effect on the market price of the outstanding shares.

*

Stock Dividends

LO 2

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Illustration: Medland Corporation declares a 10% stock dividend on

its 50,000 shares of $10 par value common stock. The current fair

market value of its stock is $15 per share. Record the entry on the

declaration date:

Stock Dividends (50,000 x 10% x $15) 75,000

Common Stock Dividends Distributable 50,000

Paid-in Capital in Excess of Par—Common 25,000

Illustration 14-4Statement Presentation

ENRTIES FOR STOCK DIVIDENDS

LO 2

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Illustration: Medland Corporation declares a 10% stock dividend on

its 50,000 shares of $10 par value common stock. The current fair

market value of its stock is $15 per share. Record the entry on the

declaration date:

Stock Dividends (50,000 x 10% x $15) 75,000


Paid-in Capital in Excess of Par—Common 25,000


Common Stock 50,000

Record the journal entry when Medland issues the dividend shares.

LO 2

ENRTIES FOR STOCK DIVIDENDS

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EFFECTS OF STOCK DIVIDENDSIllustration 14-5

Stock Dividends

LO 2

14-20

Which of the following statements about small stock dividends

is true?

a. A debit to Stock Dividends for the par value of the shares

issued should be made.

b. A small stock dividend decreases total stockholders’

equity.

c. Market value per share should be assigned to the

dividend shares.

d. A small stock dividend ordinarily will have an effect on par

value per share of stock.

Question

Stock Dividends

LO 2

14-21

In the stockholders’ equity section, Common Stock Dividends

Distributable is reported as a(n):

a. deduction from total paid-in capital and retained earnings.

b. current liability.

c. deduction from retained earnings.

d. addition to capital stock.

Question

Stock Dividends

LO 2

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Stock Splits

Issuance of additional shares to stockholders according to

their percentage ownership.

Reduction in the par or stated value per share.

Increase in number of shares outstanding.

Reduces the market value of shares.

No journal entry recorded.Helpful Hint A stock split changes the par value per share but does not affect any balances in stockholders’ equity.

LO 2

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Effect of 4-for-1 stock split for stockholdersIllustration 14-6

Stock Splits

LO 2

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Effects for Medland Corporation, assuming that it splits its

50,000 shares of common stock on a 2-for-1 basis.Illustration 14-7

Stock Splits

LO 2

14-25 LO 2

Investor Insight Berkshire Hathaway

A No-Split Philosophy

Warren Buffett’s company, Berkshire Hathaway, has two classes of shares. Until recently, the company had never split either class of stock. As a result, the class A stock had a market price of$97,000 and the class B sold for about $3,200 per share. Because the price per share is so high, the stock does not trade as frequently as the stock of other companies. Buffett has always opposed stock splits because he feels that a lower stock price attracts short-term investors. He appears to be correct. For example, while more than 6 million shares of IBM are exchanged on the average day, only about 1,000 class A shares of Berkshire are traded. Despite Buffett’s aversion to splits, in order to accomplish a recent acquisition, Berkshire decided to split its class B shares 50 to 1.

Source: Scott Patterson, “Berkshire Nears Smaller Baby B’s,” Wall Street Journal Online (January 19, 2010).

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DO IT! Stock Dividends and Stock Splits2

Sing CD Company has had five years of record earnings. Due to

this success, the market price of its 500,000 shares of $2 par value

common stock has tripled from $15 per share to $45. During this

period, paid-in capital remained the same at $2,000,000. Retained

earnings increased from $1,500,000 to $10,000,000. President Joan

Elbert is considering either a 10% stock dividend or a 2-for-1 stock

split. She asks you to show the before-and-after effects of each

option on retained earnings, total stockholders’ equity, and par value

per share.

LO 2

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DO IT! Stock Dividends and Stock Splits2

Sing CD Company has had five years of record earnings. Due to

this success, the market price of its 500,000 shares of $2 par value

common stock has tripled from $15 per share to $45. President

Joan Elbert is considering either a 10% stock dividend or a 2-for-1

stock split.

LO 2

14-28 LO 3

Retained earnings is net income that a company retains in

the business.

Part of the stockholders’ claim on the total assets of the

corporation.

Debit balance in Retained Earnings is identified as a

deficit.

LEARNINGOBJECTIVE

Prepare and analyze a comprehensive stockholders’ equity section.

3

Illustration 14-10Stockholders’ equity with deficit

14-29

Restrictions can result from:

1. Legal restrictions.

2. Contractual restrictions.

3. Voluntary restrictions.

RETAINED EARNINGS RESTRICTIONS

Retained Earnings

Illustration 14-11Disclosure of restriction

LO 3

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Correction of an error in previously issued financial

statements.

Result from:

► mathematical mistakes.

► mistakes in application of accounting principles.

► oversight or misuse of facts.

Adjustment made to the beginning balance of retained

earnings.

PRIOR PERIOD ADJUSTMENTS

Retained Earnings

LO 3

14-31

Balance, January 1 1,050,000$ Net income 360,000 Dividends (300,000) Balance, December 31 1,110,000$

For the Year Ended December 31, 2017Statement of Retained Earnings

Woods, Inc.

Before issuing the report for the year ended December 31, 2017, you discover a $50,000 error (net of tax) that caused the 2016 inventory to be overstated (overstated inventory caused COGS to be lower and thus net income to be higher in 2016. Would this discovery have any impact on the reporting of the Statement of Retained Earnings for 2017?

RETAINED EARNINGS STATEMENT

LO 3

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Balance, January 1, as previously reported 1,050,000$ Prior period adjustment - error correction (50,000) Balance, January 1, as restated 1,000,000 Net income 360,000 Dividends (300,000) Balance, December 31 1,060,000$

For the Year Ended December 31, 2017Statement of Retained Earnings

Woods, Inc.

Advance slide in slide show to reveal answer. LO 3


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Debits and Credits to Retained Earnings

Illustration 14-13

LO 3


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Illustration 14-14Retained earnings statement

LO 3


14-35

All but one of the following is reported in a retained

earnings statement. The exception is:

a. cash and stock dividends.

b. net income and net loss.

c. some disposals of treasury stock below cost.

d. sales of treasury stock above cost.

Question

LO 3


14-36

Statement Presentation and Analysis

LO 3

Illustration 14-15Comprehensive stockholders’equity section

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Ratio shows how many dollars of net income the company earned

for each dollar invested by the common stockholders.

Statement Presentation and Analysis

ANALYSIS

To illustrate, Walt Disney Company’s beginning-of-the-year and end-

of-the-year common stockholders’ equity were $31,820 and $30,753

million, respectively. Its net income was $4,687 million, and no

preferred stock was outstanding. Illustration 14-16

LO 3

14-38

DO IT! Retained Earnings Statement3

Vega Corporation has retained earnings of $5,130,000 on

January 1, 2017. During the year, Vega earned $2,000,000 of

net income. It declared and paid a $250,000 cash dividend. In

2017, Vega recorded an adjustment of $180,000 due to the

understatement (from a mathematical error) of 2016

depreciation expense. Prepare a retained earnings statement

for 2017.

LO 3

14-39

Prepare a retained earnings statement for 2017.

Advance slide in slide show to reveal the missing amounts. LO 3

DO IT! Retained Earnings Statement3

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Income Statement Presentation

LEARNINGOBJECTIVE

Describe the form and content of corporation income statements.

4

Illustration 14-17Income statement with income taxes

LO 4

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Net Income minus Preferred DividendsEarnings

Per Share =

Weighted-Average Common Shares Outstanding

Ratio indicates the net income

earned by each share of

outstanding common stock.

Income Statement Analysis

EPS AND PREFERRED DIVIDENDS

LO 4

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The income statement for Nadeen, Inc. shows income before income taxes $700,000, income tax expense $210,000, and net income $490,000. If Nadeen has 100,000 shares of common stock outstanding throughout the year, earnings per share is:

a. $7.00.

b. $4.90.

c. $2.10.

d. No correct answer is given.

Question

($490,000 / 100,000 = $4.90)

Income Statement Analysis

LO 4

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People, Planet, and Profit Insight

LO 4

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DO IT! Stockholders’ Equity and EPS4

(a) Compute return on common stockholders’ equity for each year.

LO 4

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DO IT! Stockholders’ Equity and EPS4

(b) Compute earnings per share for each year.

LO 4

14-46

Key Points

Similarities

The accounting related to prior period adjustment is essentially the same under IFRS and GAAP.

The stockholders’ equity section is essentially the same under IFRS and GAAP. However, terminology used to describe certain components is often different. These differences are discussed in Chapter 13.

LEARNINGOBJECTIVE

Compare the accounting for dividends, retained earnings, and income reporting under GAAP and IFRS.

5

LO 5

A Look at IFRS

14-47

Key Points

The income statement using IFRS is called the statement of comprehensive income. A statement of comprehensive income is presented in a one- or two-statement format. The single-statement approach includes all items of income and expense, as well as each component of other comprehensive income or loss by its individual characteristic. In the two-statement approach, a traditional income statement is prepared. It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items. Regardless of which approach is reported, income tax expense is required to be reported.

The computations related to earnings per share are essentially the same under IFRS and GAAP.

LO 5

A Look at IFRS

14-48

Key Points

Differences

Under IFRS, the term reserves is used to describe all equity accounts other than those arising from contributed (paid-in) capital. This would include, for example, reserves related to retained earnings, asset revaluations, and fair value differences.

IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.

Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and share holders’ funds.

LO 5

A Look at IFRS

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Looking to the Future

The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements. For example, it is likely that the statement of stockholders’ equity and its presentation will be examined closely.

Both the IASB and FASB are working toward convergence of any remaining differences related to earnings per share computations.

LO 5

A Look at IFRS

14-50

IFRS Self-Test Questions

The basic accounting for cash dividends and stock dividends:

a) is different under IFRS versus GAAP.

b) is the same under IFRS and GAAP.

c) differs only for the accounting for cash dividends between

GAAP and IFRS.

d) differs only for the accounting for stock dividends between

GAAP and IFRS.

LO 5

A Look at IFRS

14-51

Under IFRS, a statement of comprehensive income must

include:

a) accounts payable.

b) income tax expense.

c) retained earnings.

d) preference stock.


LO 5

A Look at IFRS

14-52

A Look at IFRS


Earnings per share computations related to IFRS and GAAP:

a) are essentially similar.

b) result in an amount referred to as earnings per share.

c) must deduct preferred (preference) dividends when

computing earnings per share.

d) All of the answer choices are correct.

LO 5

A Look at IFRS

14-53

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