1 4 Corporations Dividends Retained Earnings and Income

1 4 Corporations: Dividends, Retained Earnings, and Income Reporting Learning Objectives 14 -1 1 Explain how to account for cash dividends. 2 Explain how to account for stock dividends and splits. 3 Prepare and analyze a comprehensive stockholders’ equity section. 4 Describe the form and content of corporation income statements.

LEARNING OBJECTIVE 1 Explain how to account for cash dividends. Distribution of cash or stock to stockholders on a pro rata (proportional to ownership) basis. Types of Dividends: 1. Cash dividends. 3. Stock dividends. 2. Property dividends. 4. Scrip (promissory note to pay cash in the future). as a dollar Dividends are generally reported quarterly amount per share. (Sometimes they are reported on an annual basis. For example, Nike’s quarterly dividend rate in the fourth quarter of 2013 was 24 cents per share) 14 -2 LO 1

Cash Dividends 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. (Cash dividend distributions from only the balance in common stock (legal capital) are illegal. A dividend declared out of paid-in capital is termed a liquidating dividend. Such a dividend reduces or “liquidates” the amount originally paid in by stockholders). 2. Adequate cash. 3. A declaration of dividends by the Board of Directors. 14 -3 LO 1

Cash Dividends Three dates are important: 14 -4 Illustration 14 -1 Key dividend dates LO 1

Cash Dividends 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 Payable 50, 000 Dec. 22 (Date of Record) At the record date, the company determines ownership of the outstanding shares for dividend purposes. No entry Jan. 20 (Payment Date) Dividends Payable Cash 14 -5 50, 000 LO 1

Cash Dividends l At the end of the fiscal year, the cash dividends account should be closed in the retained earning account: Retained Earnings 50, 000 Cash Dividends 50, 000 (To close Cash Dividends to Retained Earnings) 14 -6 LO 1

Dividend Preferences u Preferred Stockholders have the 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. u Cumulative Dividend Preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders receive dividends. u 14 -7 LO 1

Dividend Preferences 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) Or (5000 share * $100 *7%). If dividends are two years in arrears, preferred stockholders are entitled to receive the following dividends Illustration 14 -2 Computation of total dividends to preferred in the current year. stock 14 -8 Advance slide in slide show to reveal dividend amounts. LO 1

Dividend Preferences 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. 14 -9 LO 1

ALLOCATING CASH DIVIDENDS 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. Cash Dividends 6, 000 Dividends Payable 6, 000 Preferred Dividends: 1, 000 shares x $100 par x 8% = $8, 000 Because of the cumulative feature, dividends of $2 ($8 - $6) per share in arrears on preferred stock for 2017 (8, 0006000 = 2000). IBR must pay these dividends to preferred stockholders before it can pay any future dividends to LO 1 14 -10 common stockholders.

ALLOCATING CASH DIVIDENDS 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 14 -11 ** * * 1, 000 shares x $100 par x 8% = $8, 000 ** 2017 Pfd. dividends $8, 000 – declared $6, 000 = $2, 000 LO 1

ALLOCATING CASH DIVIDENDS Illustration: At December 31, 2018, IBR declares a $50, 000 cash dividend. Prepare the entry to record the declaration of the dividend. Cash Dividends 50, 000 Dividends Payable 14 -12 50, 000 LO 1

DO IT! 1 Dividends on Preferred and Common Stock Master. Mind 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 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). 14 -13 LO 1

DO IT! 1 Dividends on Preferred and Common Stock Master. Mind 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. 2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years. Solution Past unpaid dividends do not have to be paid. Preferred stockholders = $12, 000 (2, 000 x. 06 x $100). Common stockholders = $48, 000 ($60, 000 - $12, 000). 14 -14 LO 1

DO IT! 1 Dividends on Preferred and Common Stock Master. Mind 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. 3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years. Solution Dividends that have been missed (dividends in arrears) must be paid. Preferred stockholders = $36, 000 (3 x 2, 000 x. 06 x $100). Common stockholders = $24, 000 ($60, 000 - $36, 000). 14 -15 LO 1

LEARNING OBJECTIVE 2 Explain how to account for stock dividends and splits. Stock Dividends 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. 14 -16 LO 2

Stock Dividends When the dividend is declared, the board of directors determines the size of the stock dividend and the value assigned to each dividend. u Small stock dividend (less than 20– 25% of the corporation’s issued stock, recorded at fair market value). This treatment is based on the assumption that a small stock dividend will have little effect on the market price of the shares previously outstanding. 14 -17 u Large stock dividend (greater than 20– 25% of issued stock, recorded at par value). u Small stock dividends predominate in practice. Thus, we will illustrate only entries for small stock dividends. LO 2

ENRTIES FOR STOCK DIVIDENDS 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— 25, 000 Common Similar to Cash Dividends, Stock Dividends decrease retained earnings. Statement Presentation before it issues the dividend shares, it will report the distributable account under paid-in capital 14 -18 Illustration 14 -4

ENRTIES FOR STOCK DIVIDENDS 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) Common Stock Dividends Distributable Paid-in Capital in Excess of Par— Common 75, 000 50, 000 25, 000 Record the journal entry when Medland issues the dividend shares. Common Stock Dividends Distributable 50, 000 Common Stock 14 -19 50, 000 LO 2

Stock Dividends EFFECTS OF STOCK DIVIDENDS Illustration 14 -5 Total stockholders’ equity remains the same. Stock dividends also have no effect on the par or stated value per share, but the number of shares outstanding increases. 14 -20 LO 2

Stock Dividends Question 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. 14 -21 LO 2

Stock Dividends Question 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. 14 -22 LO 2

Stock Splits u A stock split, like a stock dividend, involves issuance of additional shares to stockholders according to their percentage ownership. u Reduction in the par or stated value per share. u Increase in number of shares outstanding. u Reduces the market value of shares by lowering its market price per share. This, in turn, makes it easier for the corporation to issue additional stock. u 14 -23 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

Stock Splits Effect of 4 -for-1 stock split for stockholders Illustration 14 -6 14 -24 LO 2

Stock Splits Effects for Medland Corporation, assuming that it splits 50, 000 shares of common stock on a 2 -for-1 basis. Illustration 14 -7 A stock split does not have any effect on total paid-in capital, retained earnings, or total stockholders’ equity. 14 -25 LO 2

Stock Dividend and stock Splits Differences of the effects of stock dividend and stock split Illustration 14 -8 14 -26 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). 14 -27 LO 2

DO IT! 2 Stock Dividends and Stock Splits 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. Retained earnings increased from $1, 500, 000 to $10, 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. 14 -28 LO 2

DO IT! 2 Stock Dividends and Stock Splits 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. 14 -29 LO 2

LEARNING OBJECTIVE 3 Prepare and analyze a comprehensive stockholders’ equity section. Retained earnings is net income that a company retains in the business. u Part of the stockholders’ claim on the total assets of the corporation. u Debit balance in Retained Earnings is identified as a deficit (loss). A company reports a deficit as a deduction in the stockholders’ equity section. Illustration 14 -10 Stockholders’ equity with deficit 14 -30 LO 3

Retained Earnings RETAINED EARNINGS RESTRICTIONS Restrictions can result from: 1. Legal restrictions. 2. Contractual restrictions ( Long-term debt contracts to increases the likelihood that the corporation will be able to meet required loan payments). 3. Voluntary restrictions. Companies generally disclose retained earnings restrictions in the notes to the Illustration 14 -11 financial statements Disclosure of restriction 14 -31

Retained Earnings PRIOR PERIOD ADJUSTMENTS u Correction of an error in previously issued financial statements. u Result from: u 14 -32 ► mathematical mistakes. ► mistakes in application of accounting principles. ► oversight or misuse of facts. Adjustment made to the beginning balance of retained earnings. reporting the correction in the current year’s income statement would be incorrect because it applies to a prior year’s income statement. LO 3

RETAINED EARNINGS STATEMENT 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? 14 -33 LO 3

RETAINED EARNINGS STATEMENT 14 -34 Advance slide in slide show to reveal answer. LO 3

RETAINED EARNINGS STATEMENT Debits and Credits to Retained Earnings Taccount 14 -35 Illustration 14 -13 LO 3

RETAINED EARNINGS STATEMENT Illustration 14 -14 Retained earnings statement 14 -36 LO 3

RETAINED EARNINGS STATEMENT Question 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. 14 -37 LO 3

Statement Presentation and Analysis Illustration 14 -15 Comprehensive stockholders’ equity section 14 -38 LO 3

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 Ratio shows how many dollars of net income the company earned for each dollar invested by the common stockholders. 14 -39 LO 3

DO IT! 3 Retained Earnings Statement Vega Corporation has retained earnings of $5, 130, 000 on January 1, 2017. During the year, Vega earned $2, 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. 14 -40 LO 3

DO IT! 3 Retained Earnings Statement Prepare a retained earnings statement for 2017. 14 -41 Advance slide in slide show to reveal the missing amounts. LO 3

LEARNING OBJECTIVE 4 Describe the form and content of corporation income statements. Income Statement Presentation Illustration 14 -17 Income statement with income taxes 14 -42 LO 4

Income Statement Analysis EPS AND PREFERRED DIVIDENDS Earnings Per Share = Net Income minus Preferred Dividends Weighted-Average Common Shares Outstanding Ratio indicates the net income earned by each share of outstanding common stock. 14 -43 LO 4

Income Statement Analysis Question 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. ($490, 000 / 100, 000 = $4. 90) c. $2. 10. d. No correct answer is given. 14 -44 LO 4

People, Planet, and Profit Insight 14 -45 LO 4

DO IT! 4 Stockholders’ Equity and EPS (a) Compute return on common stockholders’ equity for each year. 14 -46 LO 4

DO IT! 4 Stockholders’ Equity and EPS (b) Compute earnings per share for each year. 14 -47 LO 4

A Look at IFRS LEARNING OBJECTIVE 5 Compare the accounting for dividends, retained earnings, and income reporting under GAAP and IFRS. Key Points Similarities 14 -48 u The accounting related to prior period adjustment is essentially the same under IFRS and GAAP. u 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. LO 5

A Look at IFRS Key Points 14 -49 u 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 twostatement 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. u The computations related to earnings per share essentially LO 5 the same under IFRS and GAAP.

A Look at IFRS Key Points Differences 14 -50 u 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. u 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. u 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 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. 14 -51 LO 5

A Look at 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. 14 -52 LO 5

A Look at IFRS Self-Test Questions Under IFRS, a statement of comprehensive income must include: a) accounts payable. b) income tax expense. c) retained earnings. d) preference stock. 14 -53 LO 5

A Look at IFRS Self-Test Questions 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. 14 -54 LO 5

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