cash dividends

7/31/2019 Cash Dividends

1/14

1

Cash dividends

Net income results from management's activities. The long-term effect of net income is anincrease in the company's resources and its sources of resources (stockholders' equity, retainedearnings). Corporations distribute to owners some of the resources generated by management

(net income) in the form of cash dividends. A corporation's board of directors has theresponsibility for declaring cash dividends. If it determines the company should distribute cashdividends to owners, the board of directors declares a cash dividend. The board determines thedollar amount of the dividends and the date on which they will be paid. Because it takes time toidentify all the owners and distribute checks to them, dividends are paid several days or weeksafter they are declared.

Assume a corporation's board of directors declares a $2,000 cash dividend on July 10, with thedividend to be paid on August 12. Show the effects on the company's resources and sources ofresources.

TotalResources =

Sources ofBorrowedResources +

Sources ofOwner Invested

Resources +

Sources ofManagementGeneratedResources

Assets = Liabilities + Stockholders' Equity+ $2,000

dividends payable+ - $2,000

dividends

The company's resources (assets) do not change as a result of the July 10 declaration ofdividends because the cash will not be paid out until later (August 12). The company's sources of

resources increase and decrease by the $2,000 dividends declared. Liabilities increase by $2,000because the company now owes its owners $2,000 more. Stockholders' equity decreases by$2,000 because the owners now have rights to $2,000 less of the company's resources. In effect,the owners have given up their ownership rights to $2,000 of the company's resources for $2,000of rights as creditors: the owners have become creditors. The decrease in stockholders' equity isshown as a decrease in sources of management generated resources because dividends, bydefinition, come out of those resources generated by management. Dividends are not returns toowners of some of the resources they invested in the corporation.

Remembering that assets increase with debits and that debits must equal credits, prepare thejournal entry to record the $2,000 cash dividend declaration.

Date DescriptionPost.Ref. Debits Credits

July 10 Dividends 2,000

Dividends Payable 2,000

Cash dividends declared


2/14

2

On August 12, the corporation pays the $2,000 cash dividend declared on July 10. Show theeffects on the company's resources and sources of resources.

TotalResources =

Sources ofBorrowedResources +

Sources ofOwner InvestedResources +

Sources of

ManagementGeneratedResources

Assets = Liabilities + Stockholders' Equity- $2,000

cash= - $2,000

dividends payable

The cash dividend payment reduces the company's resources (assets) as the cash flows out toowners. The company's sources of resources (liabilities) decrease by $2,000 because thecompany no longer owes them the $2,000 once the dividends are paid.

Remembering that assets increase with debits and that debits must equal credits, prepare thejournal entry to record the $2,000 cash dividend payment.

Date DescriptionPost.Ref. Debits Credits

Aug. 12 Dividends Payable 2,000

Cash 2,000

Cash dividends paid

As a result of declaring and paying cash dividends, the company's resources and sources of

resources both decreased by $2,000. While it is important to management to keep ownerssatisfied by giving them some of the resources generated by the company, cash dividends dodecrease the amount of resources managers will be able to use in the future. Corporations mustcontinually evaluate this need to pay owners versus the need to keep resources for managementto use in the future.

Distributing cash dividends If a corporation has both preferred stockholders and commonstockholders, the distribution of cash dividends depends upon the number of shares of stockowned by the stockholders (called outstanding shares) and the preferences of the preferredstockholders. For example, consider a company with the contributed capital shown below.

Contributed Capital8% Preferred Stock, $10 par, 5,000 shares

authorized, 1,000 shares issued $10,000Common Stock, $2 par, 40,000 shares authorized,

10,000 shares issued $20,000Additional Paid-in Capital, Preferred Stock $2,000Additional Paid-in Capital, Common Stock $30,000


3/14

3

Total Contributed Capital $62,000

The company has both preferred stockholders and common stockholders. The preferredstockholders own 1,000 shares (shares issued by the company) out of a total of 5,000 shares thecompany's articles of incorporation allow it to issue (called authorized shares). The preferred

stock has a par value of $10 per share and a dividend rate of 8%. Notice the $10,000 in thepreferred stock account is the par value of the number of shares issued ($10 par x 1,000 sharesissued = $10,000). The 8% dividend rate entitles the preferred stockholders to a dividend of 8%of the preferred stock's par value in the year in which a dividend is declared. Thus, on an annualbasis, preferred stockholders could receive cash dividends of $.80 per share (.08 x $10 par =$.80). In total, preferred stockholders could receive cash dividends of $800 (.08 x $10 par x1,000 shares outstanding = $800). The preferred stockholders would receive the $800 before anycash dividends would be paid to common stockholders.

Based on the company's contributed capital, its $2,000 cash dividends would be distributed asfollows.

Preferred stock dividends (.08 x $10 par x 1,000 shares) $800Common stock dividends ($2,000 - $800) $1,200Total dividends $2,000

Preferred stockholders would receive cash dividends of $.80 per share before dividends would bepaid to common stockholders. This is one of the advantages (preferences) of owning preferredstock. Common stockholders would receive cash dividends of $.12 per share ($1,200 dividends /10,000 common shares outstanding = $.12).

** You now have the background to do text exercises 12.7, 12.8, and 12.9.

Cumulative preferred stockOne popular way companies make preferred stock attractive toinvestors is to add the cumulative preference. Remember, preferred stock is issued to obtainresources for management to use. The more attractive the preferred stock is to investors, theeasier it is to obtain resources. The cumulative preference entitles preferred stockholders toreceive dividends before common stockholders, even if the company failed to pay dividends in aprior year. Again, remember that owners receive dividends only after they have been declared bythe board of directors. If dividends are not declared, they cannot be received by owners. Thus,without the cumulative feature, preferred stockholders would not receive dividends for any yearin which the board of directors did not declare them. With the cumulative feature, however,preferred stockholders are guaranteed to receive their dividends for all years before the companycan distribute any dividends to common stockholders.

Consider again the $2,000 cash dividend discussed previously. Assume the board of directors didnot declare dividends in the previous year, but instead kept the resources in the company formanagement to use.


4/14

4

Without the cumulative feature, preferred stockholders would have lost their right to the $800cash dividends for that prior year. If, however, the preferred stock was cumulative, the $2,000cash dividend declared this year would be distributed as follows.

Preferred stock dividends (last year's dividend) $800Preferred stock dividends (this year's dividend) $800Common stock dividends ($2,000 - $1,600) $400Total dividends $2,000

Preferred stockholders would receive cash dividends of $1.60 per share ($1,600 dividends /1,000 shares = $1.60) before dividends would be paid to common stockholders. Thus, thepreferred stockholders would receive last year's and this year's dividends. Common stockholderswould receive cash dividends of $.04 per share ($400 dividends / 10,000 common sharesoutstanding = $.04). Dividends protection can be attractive to preferred stockholders, especiallyif a company has a history of not declaring dividends each year. If preferred stockholders find

dividends protection attractive, it should be easier for a company to obtain resources from them.

There are other popular preferences designed to make preferred stock attractive to investors. Forexample, preferred stock can be participating and/or convertible. Participating preferred stockallows preferred stockholders to receive dividends in excess of the stock's stated dividendpercentage. For example, if the above 8% preferred stock were participating, under certaincircumstances preferred stockholders could receive dividends greater than 8%. Convertiblepreferred stock allows owners to change (or convert) their preferred stock into common stockunder certain conditions. This conversion to common stock would allow preferred stockholdersto take advantage of rapid increases in the value of the company's common stock. Regardless ofthe preferred stock preferences, it is important to remember that preferred stock is a source of

resources to companies. In order to obtain resources, companies make use of various preferencesto make preferred stock attractive for investors.

Practice Exercise

On January 31, the Christopher Corporation had 20,000 shares of $100 par, 10%, cumulativepreferred stock outstanding and 5,000,000 shares of $.02 par common stock outstanding. OnFebruary 15, the Christopher Corporation paid cash dividends of $700,000 on shares outstandingon January 31. The Christopher Corporation did not pay cash dividends in the previous year.

1. Calculate the total cash dividends paid on February 15 to preferred stockholders.

On an annual basis, the cash dividends to be paid to preferred stockholders are $200,000 (20,000preferred shares x $100 par value per share x .10 dividend rate = $200,000). Since the preferredstock is cumulative, any unpaid dividends from previous years must be paid to preferredstockholders before any of this year's dividends can be paid. Thus, since the ChristopherCorporation had not paid the $200,000 dividends in the previous year, this year the preferredstockholders would receive $400,000, $200,000 for the previous year and $200,000 for this year.


5/14

5

2. Calculate the cash dividend per share paid to preferred stockholders on February 15.

$400,000 cash dividends / 20,000 preferred shares = $20 dividends per share of preferred stock.

3. Calculate the total cash dividends paid on February 15 to common stockholders.

Total cash dividends $700,000Less: Dividends to preferred stockholders $400,000Dividends to common stockholders $300,000

4. Calculate the cash dividend per share paid to common stockholders on February 15.

$300,000 cash dividends / 5,000,000 common shares = $.06 dividends per share of commonstock.

** You now have the background to do text exercises 12.10, 12.11, and 12.12.


6/14

6

rnings per Share

SFAS No. 128

Statement of Financial Accounting Standards (SFAS) No. 128a. Earnings per Shareb. Issued in February 1997

c. SFAS No. 128 supersedes APB Opinion No. 15, Earnings per Share, May 1969

Basic Earnings per Share (EPS)

--> Basic EPS = BE / BS

--> BE = income available to common stockholders--> BS = weighted-average number of common shares outstanding

Income available to common stockholders--> Net income

- dividends on preferred stock (declared in the period)

- dividends on cumulative preferred stock (accumulated for the period)

Diluted Earnings per Share (EPS)--> Diluted EPS = DE / DS

--> DS = BS + Dilutive potential common shares

--> DE = BE + Dilutive effect of assumed conversions--> DE = BE + convertible preferred dividends

+ interest (after-tax) on convertible debt+ effect of assumed conversion of potential common shares

Antidilution is not allowedIf assumed conversion has an antidilutive effect on EPS

--> such conversion is not assumed.

a. Antidilutive effect on EPS--> Diluted EPS > Basic EPS

b. If income from continuing operations < 0,(loss from continuing operations)

--> Potential common shares are not added.(Diluted EPS = Basic EPS)

--> even if net income > 0.

Treasury Stock Method

--> Dilutive effect of call options and warrants

a. Exercise of options and warrants

--> assumedat the beginning of the period orat the time of issuance, whichever is later.

b. Proceeds from exercise--> assumed to be used

to purchase common stock


7/14

7

at the average market price during the period.

c. Incremental shares

--> includedin the denominator of diluted EPS

Stock-based compensation to employeesFixed awards and nonvested stock to be issued--> considered outstanding

as ofgrant date.

If-Converted Method--> Convertible securities

a. Preferred dividends to convertible preferred stock--> added to income available to common stockholders.

b. Interest charges (after-tax) to convertible debt--> added to income available to common stockholders.

c. Convertible preferred stock or convertible debt--> assumed to be converted

at the beginning of period or

at the time of issuance, whichever is later.

d. Conversion is not assumed

--> if the effect is antidilutive. (Diluted EPS > Basic EPS)

Stock Dividends or Stock Splits

Basic and diluted EPS--> adjusted retroactively

for all periods presented.

sic EPS

Basic Earnings per Share (EPS)--> Basic EPS = BE / BS

--> BE = income available to common stockholders--> BS = weighted-average number of common shares outstanding

Example 1 (Issuance of stock)

mpany A had

,000,000 shares of common stock outstanding on January 1, 2011.Net income for 2006 is $4,500,000.

Additional stock transactions:

April 1, 2011 Issuance of common stock 600,000 shares

November 1, 2011 Purchase of treasury stock 120,000 shares


8/14

8

Weighted average number of common shares:

Dates outstanding Shares outstanding Fraction of periodWeighted average

shares

1/1 - 3/31 3,000,000 3/12 750,000

Issuance on 4/1 600,000

4/1 - 10/31 3,600,000 7/12 2,100,000

Purchase on 11/1 120,000

11/1 - 12/31 3,480,000 2/12 580,000

Weighted average number of common

shares outstanding3,430,000

Basic EPS = $4,500,000 / 3,430,000 shares = $1.31


3,000,000 shares x 3/12 = 750,000 shares3,600,000 shares x 7/12 = 2,100,000 shares3,480,000 shares x 2/12 = 580,000 shares

Total 3,430,000 shares

Example 2 (Stock dividend and split)

mpany B had,000,000 shares of common stock outstanding on January 1, 2011.

Net income for 2006 is $8,000,000.

Additional stock transactions:April 1, 2011 Issuance of common stock 600,000 sharesMay 1, 2011 10% stock dividend

November 1, 2011 2-for-1 stock split


Dates outstanding Shares outstandingEffect ofStock

Dividend

Effect of

Stock Split

Fraction of

period

Weighted ave

shares

1/1 - 3/31 3,000,000 1.10 2.00 3/12 1,650,000

Issuance on 4/1 600,000

4/1 - 4/30 3,600,000 1.10 2.00 1/12 660,000

10% stock dividend, 5/1 360,000

5/1 - 10/31 3,960,000 2.00 6/12 3,960,000

2-for-1 stock split, 11/1 3,960,000


9/14

9

11/1 - 12/31 7,920,000 2/12 1,320,000

Weighted average number ofommon shares outstanding

7,590,00

Basic EPS = $8,000,000 / 7,590,000 shares = $1.05

Alternatively,


3,000,000 shares x 3/12 = 750,000 shares

3,600,000 shares x 9/12 = 2,700,000 shares

Total 3,450,000 shares

Effect of stock dividend x 1.1

Effect of stock split x 2.0

Weighted average = 7,590,000 shares

Stock Dividends or Stock Splits--> adjust the number of shares outstanding retroactively

for all periods presented.

Due to retroactive adjustments,

--> dates (during the year) of stock dividends and splits

do not affect the number of shares outstanding.

Example 3 (Preferred stock dividend)

mpany C had,000,000 shares of common stock outstanding on January 1, 2011.

referred stock outstanding:200,000 shares of 5% cumulative preferred stock ($10 par)

Net income:

2011: $4,600,0002012: - $1,100,000 (loss)

referred stock dividend declared:

2011: $100,000

2012: $0


2011: 3,000,000 shares2012: 3,000,000 shares

Income available to common stockholders:2011: $4,600,000 - $100,000 (*1) = $4,500,000


10/14

10

2012: - $1,100,000 - $100,000 (*2) = - $1,200,000 (loss)

(*1) $100,000 dividend on preferred stock (declared in the period)

(*2) $100,000 dividend on cumulative preferred stock (accumulated for the period)

Preferred stock dividend

= ($10 par x 5%) x 200,000 shares= $.50 x 200,000 shares = $100,000

Basic EPS:

2011: $4,500,000 / 3,000,000 shares = $1.50 per share2012: - $1,200,000 / 3,000,000 shares = - $.40 per share (loss)

ncome available to common stockholders--> Net income

- dividends on preferred stock (declared in the period)

- dividends on cumulative preferred stock (accumulated for the period)

f there is a loss,

--> amount of loss is increased by preferred dividends.

uted EPS, Treasury Stock Method

Basic Earnings per Share (EPS)

--> Basic EPS = BE / BS--> BE = income available to common stockholders--> BS = weighted-average number of common shares outstanding

Diluted Earnings per Share (EPS)--> Diluted EPS = DE / DS

--> DS = BS + Dilutive potential common shares

Example 4 (Treasury stock method)

mpany D had

,000,000 shares of common stock outstanding on January 1, 2011.Net income for 2011 is $4,650,000.

Stock options and warrants issued:April 1, 2011: Options for 200,000 shares, $20 per share exercise priceOctober 1, 2011: Warrants for 250,000 shares, $30 per share exercise price

Average market price of Company A's common stock during 2011: $50

Weighted average number of common shares: 3,000,000

Income available for common stockholders: $4,650,000

Basic EPS = $4,650,000 / 3,000,000 shares = $1.55

Incremental shares from stock options:a. Proceeds from assumed exercise:

--> April 1, 2011: 200,000 shares x $20 = $4,000,000


11/14

11

b. Number of shares assumed to be repurchased:

--> $4,000,000 / $50 = 80,000 shares

c. Incremental shares from assumed exercise:--> Incremental shares = 200,000 shares - 80,000 shares = 120,000 shares

Alternatively,200,000 shares - [(200,000 shares x $20 ) / $50]

= 200,000 shares x (1 - $20/$50)

= 200,000 shares x ($50/$50 - $20/$50)= 200,000 shares x [($50 - $20) / $50]= 200,000 shares x .60 = 120,000 shares

Option shares x [(Average market price - Exercise price) / Average market price]

Incremental shares from stock warrants:

a. Proceeds from assumed exercise:--> October 1, 2011: 250,000 shares x $30 = $7,500,000

b. Number of shares assumed to be repurchased:--> $7,500,000 / $50 = 150,000 shares

c. Incremental shares from assumed exercise:

--> Incremental shares = 250,000 shares - 150,000 shares = 100,000 shares

Alternatively,250,000 shares - [(250,000 shares x $30 ) / $50]

= 250,000 shares x (1 - $30/$50)

= 250,000 shares x ($50/$50 - $30/$50)= 250,000 shares x [($50 - $30) / $50]

= 250,000 shares x .40 = 100,000 shares

Warrant shares x [(Average market price - Exercise price) / Average market price]


Dates outstanding Shares outstanding Fraction of periodWeighted average

shares

1/1 - 3/31 3,000,000 3/12 750,000

cremental shares from options on 4/1 120,000

4/1 - 9/30 3,120,000 6/12 1,560,000

ncremental shares from warrants on10/1

100,000

10/1 - 12/31 3,220,000 3/12 805,000

Weighted average number of commonshares outstanding

3,115,000

3,000,000 shares x 3/12 = 750,000 shares

3,120,000 shares x 6/12 = 1,560,000 shares


12/14

12

3,220,000 shares x 3/12 = 805,000 sharesTotal 3,115,000 shares

Diluted EPS = $4,650,000 / 3,115,000 shares = $1.49

uted EPS, If-converted Method

Basic Earnings per Share (EPS)--> Basic EPS = BE / BS

--> BE = income available to common stockholders

--> BS = weighted-average number of common shares outstanding

Diluted Earnings per Share (EPS)

--> Diluted EPS = DE / DS

--> DS = BS + Dilutive potential common shares--> DE = BE + Dilutive effect of assumed conversions

--> DE = BE + convertible preferred dividends

+ interest (after-tax) on convertible debt

+ effect of assumed conversion of potential common shares

Example 5 (If-converted method, Convertible bonds)

mpany E had,000,000 shares of common stock outstanding on January 1, 2011.


Convertible Bonds:

April 1, 2011: $1,000,000 convertible bonds, 8% annual interest rate.

$1,000 bonds can be converted to 100 shares of common stock.

ncome tax rate: 40%


Income available for common stockholders: $4,500,000Basic EPS = $4,500,000 / 3,000,000 shares = $1.50

If convertible bonds are converted:a. Incremental shares:--> April 1, 2011: ($1,000,000 / $1,000) x 100 shares = 100,000 shares

b. Weighted average number of common shares:--> 3,000,000 shares x 3/12 = 750,000 shares

3,100,000 shares x 9/12 = 2,325,000 sharesTotal = 3,075,000 shares

c. Interest expense:

--> $1,000,000 x 8% x 9/12 = $60,000

--> After tax: $60,000 x (1 - 40%) = $36,000

d. Income available to common stockholders:

--> $4,500,000 + $36,000 = $4,536,000


13/14

13


Convertible preferred stock or convertible debt--> assumed to be converted

at the beginning of period or

at the time of issuance, whichever is later.

Example 6 (If-converted method, Convertible preferred stock)

mpany F had,000,000 shares of common stock outstanding on January 1, 2011.


Cumulative preferred stock outstanding:200,000 shares of 5% cumulative preferred stock ($10 par)

100,000 shares of 3% convertible cumulative preferred stock ($20 par)

One share of convertible preferred stock ($20 par)is convertible into one share of common stock.

Preferred stock dividends:

5% ($10 par) preferred stock:


3% ($20 par) preferred stock:


Income available for common stockholders

= $3,500,000 - $100,000 - $60,000 = $3,340,000

For Basic EPS,

--> Income available for common stockholders

= Net income - all preferred stock dividends


Basic EPS = $3,340,000 / 2,000,000 shares = $1.67

If convertible preferred stocks are converted:a. Incremental shares:

--> 100,000 shares

b. Weighted average number of common shares:--> 3,000,000 shares + 100,000 shares = 3,100,000 shares

c. Dividends on convertible preferred stock:--> 3% ($20 par) preferred stock:

= ($20 par x 3%) x 100,000 shares

= $.60 x 100,000 shares = $60,000


14/14

14

d. Income available to common stockholders:

--> $3,340,000 + $60,000 = $3,400,000

For Diluted EPS (If-method method)--> Income available for common stockholders for Diluted EPS

= Income available for common stockholders for Basic EPS+Dividends on convertible preferred stock


cash dividends

Documents