Chapter 20 1 Corporate Taxes Retained Earnings and

Chapter 20 1 Corporate Taxes, Retained Earnings, and Dividends College Accounting 10 th Edition Mc. Quaig Bille Nobles Power. Point presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University 20– 1 © 2011 Cengage Learning

Procedure for Recording and Paying Income Taxes § Corporate net income is determined much like that of sole proprietorships and partnerships. § The net income of a sole proprietorship and the distribution of shares of net income of a partnership are taxable as part of each owner’s personal income. § Corporations must pay income taxes in its own name. 20– 2

Corporate Income Tax Rates Example: Taxable Income of $10, 800, 000 $3, 400, 000 + [0. 35 x $($10, 800, 000 – $10, 000)] = $3, 680, 000 20– 3

Income Tax Entries for a Corporation Red Velvet Cupcakes, Inc. , estimates that its federal income tax for the forthcoming fiscal year will be $30, 830. The firm’s accountant records four quarterly payments; the first on April 15. 20– 4

Income Tax Entries for a Corporation Red Velvet Cupcakes’s accountant determines that the taxable income of the corporation for the year is $33, 170 and that the corporation owes an additional $2, 340. The corporation is required to make full payment of its final tax with its income tax return, which would be recorded as:

Income Tax Entries for a Corporation Red Velvet Cupcakes’s total tax for the year is $33, 170. 00. First quarterly installment of estimated federal income tax $ 7, 707. 50 Second quarterly installment of estimated federal income tax 7, 707. 50 Third quarterly installment of estimated federal income tax 7, 707. 50 Fourth quarterly installment of estimated federal income tax 7, 707. 50 Additional tax owed 2, 340. 00 Total tax $33, 170. 00 20– 6

Reasons why net income shown on the income statement may differ from the income reported for tax purposes. § The depreciation method used for income statement purposes may differ from the method used for tax purposes. § Some items listed on the income statement are not taxable. § A corporation may capitalize certain types of expenditures as assets on the financial statements, and list them on the tax return as an expense. 20– 7

Closing Entries for a Corporation Red Velvet Cupcakes, Inc. , had revenues of $996, 000 and expenses of $868, 000 at the end of the fiscal year. 20– 8

Closing Entries for a Corporation STEP 1. Close revenue accounts into Income Summary. STEP 2. Close expense accounts into Income Summary. STEP 3. Close Income Tax Expense into Income Summary by the amount of the actual income tax for the year. STEP 4. Close Income Summary into Retained Earnings by the amount of the net income. 20– 9

Summary of Entries in T Account Form

Reasons for Appropriating Retained Earnings § Because a corporation declares dividends out of its Retained Earnings, the amount of dividends is necessarily limited to the amount of Retained Earnings. § The local board of directors may wish to earmark part of Retained Earnings for some specific purpose. Such a restriction constitutes an appropriation of Retained Earnings. A common reason for appropriating Retained Earnings is future expansion. 20– 11

Reasons for Appropriating Retained Earnings Red Velvet Cupcakes, Inc. , plans to erect a new store building. It decides to restrict, or appropriate, Retained Earnings for a total amount of $300, 000 at a rate of $50, 000 per year for six years. 20– 12

Reasons for Appropriating Retained Earnings § The appropriation of Retained Earnings does not represent a separate cash fund of $50, 000. § If the corporation does not declare and pay out these dividends, then the firm is preserving its net assets (assets minus liabilities), particularly cash. § When the building is bought or erected, the corporation no longer needs to restrict Retained Earnings, so the following entry is needed. 20– 13

Reasons for Appropriating Retained Earnings 20– 14

Reasons for Appropriating Retained Earnings § Retained Earnings Appropriated for Plant Expansion (no specific objective stated) § Retained Earnings Appropriated for Bond Indebtedness (an obligation imposed b contract) § Retained Earnings Appropriated for Self-Insurance (workers’ compensation or medical insurance for employees) § Retained Earnings Appropriated for Inventory Losses (in the event of a price drop) § Retained Earnings Appropriated for Contingencies (in the event of a “rainy day”) 20– 15

Declaration and Payment of a Dividend § A dividend is a distribution—of cash or other assets or shares of stock—that a corporation makes to its stockholders. § A cash dividend is the most common form of dividend. It is expressed as a specific amount per share. 20– 16

Dividend Dates Three significant dates are involved in the declaration and payment of a dividend. 1. Date of declaration 2. Date of record 3. Date of payment On January 30, the board of directors of Red Velvet Cupcakes, Inc. declares a quarterly; cash dividend of $0. 91 per share on 5, 000 shares to stockholders of record on February 11, payable on February 20. 20– 17

Dividend Dates Current Liability Date of Declaration 20– 18

Dividend Dates Date of Payment 20– 19

Retained Earnings Account 20– 20

Cash Dividends on Cumulative Preferred Stock § Preferred stock can be either cumulative preferred stock or noncumulative preferred stock. § Cumulative preferred stock accrues dividends, and noncumulative preferred stock does not accrue dividends. § Any dividends not paid in the past on cumulative preferred stock are called dividends in arrears. 20– 21

Cash Dividends on Cumulative Preferred Stock § Red Velvet Cupcakes, Inc. , has outstanding 10, 000 shares of $30 par, 8 percent, cumulative preferred stock and 80, 000 shares of $15 par value common stock. § The corporation declares and pays dividends. $24, 000 for dividends in arrears and $24, 000 for the current year 20– 22

Stock Dividends § A stock dividend is a distribution, on a pro rata basis, of additional shares of a company’s stock to the stockholders. § The dividend consists of shares of stock rather than cash. § Stock dividends are usually issued by corporations that retain cash in order to finance expansion. 20– 23

Stock Dividends The board of directors of Mom’s Bakery, Inc. , declares a 10 percent stock dividend on October 11 of Year 3 to stockholders of record as of November 1, distributable on November 16. The current market value is $47 per share (par value $40). 10% of 5, 000 = 500 shares (continued) 20– 24

Stock Dividends A stockholders’ equity account Date of Declaration 20– 25

Stock Dividends Date of Distribution (Payment) § A stock dividend—unlike a cash dividend—does not result in a reduction of assets. § The stock dividend increases the Capital Stock accounts and decreases the Retained Earnings account without changing total stockholders’ equity. § The stock dividend has no effect on the proportionate share of ownership held by an individual stockholder.

Reasons for Issuing Stock Dividends 1. Stock dividends appease stockholders by giving them additional shares of stock. 2. Stock dividends tend to increase the marketability of the company’s stock by increasing the number of shares outstanding and thereby decreasing the market price per share. 3. Stock dividends enable stockholders to postpone any income tax liability until they sell the shares. 20– 27

Stock Split § When there is a stock split, a corporation splits or sub-divides its stock, on the basis of its par or stated value, and issues a proportionate number of additional shares. § A corporation with 10, 000 shares of $50 parvalue stock outstanding reduces the par value to $25 and increase the number of shares to 20, 000 through a 2 -for-1 split. § At the date of declaration, a memorandum notion is made. 20– 28

Stock Split Because there is no change in Retained Earnings, a journal entry is not required. 20– 29

Effect of Dividends and Stock Splits on Assets and Stockholders’ Equity 20– 30

Minute Book § The minute book is an important source document for any accounting entries involving the declaration of dividends and the appropriation of Retained Earnings. § It is an electronic narrative of all actions taken at official meetings of the board of directors. § It may contain details relating to purchasing property and equipment, obtaining bank loans, and so on. 20– 31

Statement of Retained Earnings and Balance Sheet for a Corporation § Changes in Retained Earnings are reported on a separate financial statement called a statement of retained earnings. 20– 32

Statement of Retained Earnings 20– 33

Balance Sheet 20– 34

Balance Sheet 20– 35

Balance Sheet 20– 36

Full Disclosure § The guideline of full disclosure requires that anyone preparing a financial statement include enough information so that the statement is complete. § Example: A note about a lawsuit in which the company is involved. 20– 37

Materiality § The guideline of materiality states that relatively important data are included in financial reports. Transactions that have very little effect on the results shown in financial statements and would not be likely to influence decisions made by users are considered immaterial. § Example: Rounding numbers on the published annual report of a large corporation to make the statements easier to read is acceptable because the impact is immaterial. 20– 38

Conservatism § To be conservative means to take the safe route. According to the guideline of conservatism, accountants use the alternative that is the least likely to result in an overstatement of income or asset value. § Example: An accountant is estimating an amount of money to be received in the future. The accountant must choose between $12, 000 and $22, 000. Conservatism requires the accountant to choose the smaller amount. 20– 39