Corporations Effects on Retained Earnings and the Income

Learning Objective 1 Account for stock dividends

Stock Dividend Proportional distribution of corporation’s own stock to shareholders ◦ No cash provided

Why do Companies Issue Stock Dividends? Conserve cash Reduce market price Reward investors •

Entries for Stock Dividend Small Distribution is less than 20 to 25% of issued

Exercise 12 -13 10% x 450 = 45 share dividend GENERAL JOURNAL DATE Apr

Exercise 12 -13 (continued) Copyright (c) 2009 Prentice Hall. All rights reserved. 7

Learning Objective 2 Account for stock splits

Stock Splits Increases: ◦ the number of shares authorized, issued and outstanding Decreases: ◦

Stock Split Example A company has 25, 000 shares of $10 par common stock

Effects of Dividends and Stock Splits Event Common stock Paid-in capital in excess of

Learning Objective 3 Account for treasury stock

Treasury Stock Shares that a company has issued and later reacquired Reasons corporations purchase

Accounting for Treasury Stock Contra equity account ◦ Debit balance Recorded at cost (not

Treasury Stock Journal Entries GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Treasury stock Cash

Treasury Stock Journal Entries If treasury stock is sold above cost, the excess is

Treasury Stock: Sale Below Cost If treasury stock is sold below cost, the shortfall

Treasury Stock Journal Entries: Sale Below Cost Situation 1 – Paid-in capital from treasury

Treasury Stock Journal Entries: Sale Below Cost Situation 2 – Paid-in capital from treasury

Treasury Stock Journal Entries: Sale Below Cost Situation 3 – Paid-in capital from treasury

Review Questions Copyright (c) 2009 Prentice Hall. All rights reserved. 21

1. Which of the following is false regarding stock dividends? A. They decrease Retained

2. Small stock dividends are recorded at: A. par value. B. cost. C. market

3. Stock splits: A. reduce Retained earnings. B. require a journal entry. C. increase

4. How are cash dividends and stock dividends the same? A. Both reduce Retained

5. What type of account is Treasury stock? A. Investment B. Paid-in capital C.

Learning Objective 4 Report restrictions on retained earnings

Restrictions and Appropriations of Retained Earnings Restrictions Requirement by lenders to maintain a minimum

Learning Objective 5 Complete a corporate income statement including earnings per share

Any Corporation Income Statement Sales revenue Cost of goods sold Gross profit Operating expenses

Income from Continuing Operations Measures profitability of the ongoing operations Useful for making projections

Special Items Reported after income from continuing operations Discontinued operations Extraordinar y items Copyright

Discontinued Operations Segment of a business that has been sold ◦ Identifiable division of

Extraordinary Items Both unusual and infrequent Examples: ◦ Losses from natural disasters ◦ Foreign

Earnings Per Share (EPS) Most widely used business statistic Measures amount of net income

Earnings per share Net income – preferred dividends Average number of common shares outstanding

Exercise 12 -21 Net income – preferred dividends 1, 000 shares x $30 par

Exercise 12 -21 (continued) Average number of common shares outstanding 52, 000 shares issued

Exercise 12 -21 (continued) Net income – preferred dividends Average number of common shares

Statement of Retained Earnings Reports how retained earnings changed over the accounting period Copyright

Prior Period Adjustments Corrections to Retained earnings for errors of an earlier period Correcting

Comprehensive Income Change in total stockholders’ equity from all sources other than from its

Review Questions Copyright (c) 2009 Prentice Hall. All rights reserved. 48

6. Outstanding shares equal: A. authorized shares – issued shares. B. issued shares –

7. If treasury stock is sold above cost, which account is credited for the

8. Retained earnings restrictions: A. are reported in the notes to the financial statements.

9. Which of the following income statement amounts provides the best predictor of future

10. Which of the following are reported net of income tax effect? A. Gain

11. Which of the following would be considered an extraordinary item? A. Effects of

12. A correction to Retained earnings of an error made previously is called a(n):

Slides: 63

Download presentation

Corporations: Effects on Retained Earnings and the Income Statement Chapter 12

Learning Objective 1 Account for stock dividends

Stock Dividend Proportional distribution of corporation’s own stock to shareholders ◦ No cash provided to shareholders Does not change total stockholders’ equity ◦ Transfer of retained earnings to contributed capital Common stock Retained earnings Copyright (c) 2009 Prentice Hall. All rights reserved. 3

Why do Companies Issue Stock Dividends? Conserve cash Reduce market price Reward investors • Continue dividends without using cash • Increased supply of shares may cause price to fall • Shareholders feel they have received something of value Copyright (c) 2009 Prentice Hall. All rights reserved. 4

Entries for Stock Dividend Small Distribution is less than 20 to 25% of issued shares Debit Retained earnings for market value of shares to be distributed Large Distribution is greater than or equal to 25% of issued shares Debit Retained earnings for par or stated value of shares Rare Copyright (c) 2009 Prentice Hall. All rights reserved. 5

Exercise 12 -13 10% x 450 = 45 share dividend GENERAL JOURNAL DATE Apr 30 DESCRIPTION REF Retained earnings (45 x $17) DEBIT CREDIT 765 Common stock (45 x $1) 45 Paid-in capital in excess of par-C/S Copyright (c) 2009 Prentice Hall. All rights reserved. 720 6

Learning Objective 2 Account for stock splits

Stock Splits Increases: ◦ the number of shares authorized, issued and outstanding Decreases: ◦ par value per share ◦ market value Balances in the accounts are unchanged Record in a memorandum entry Copyright (c) 2009 Prentice Hall. All rights reserved. 9

Stock Split Example A company has 25, 000 shares of $10 par common stock outstanding A 2 -for-1 stock split is declared Results in 50, 000 shares of $5 par common stock outstanding Copyright (c) 2009 Prentice Hall. All rights reserved. 10

Effects of Dividends and Stock Splits Event Common stock Paid-in capital in excess of par Retained earnings Total stockholders’ equity Cash dividend No effect Decrease Stock dividend Increase Decrease No effect Stock split No effect Copyright (c) 2009 Prentice Hall. All rights reserved. 11

Learning Objective 3 Account for treasury stock

Treasury Stock Shares that a company has issued and later reacquired Reasons corporations purchase their own stock: ◦ ◦ To increase net assets by buying low and selling high To support the company’s stock price To avoid a takeover by an outside party To reward valued employees with stock Copyright (c) 2009 Prentice Hall. All rights reserved. 13

Accounting for Treasury Stock Contra equity account ◦ Debit balance Recorded at cost (not par) Reported beneath Retained earnings on the balance sheet ◦ Reduction to total stockholders’ equity Decreases outstanding shares ◦ Not eligible for dividends Outstanding shares Issued shares Treasury shares Copyright (c) 2009 Prentice Hall. All rights reserved. 14

Treasury Stock Journal Entries If treasury stock is sold above cost, the excess is credited to “Paid-in capital from treasury stock transactions” GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Cash Treasury stock (at cost) Paid-in capital from treasury stock transactions Copyright (c) 2009 Prentice Hall. All rights reserved. 16

Treasury Stock: Sale Below Cost If treasury stock is sold below cost, the shortfall is debited to “Paid-in capital from treasury stock transactions” IF there is a sufficient balance Otherwise, Retained earnings is debited for any remaining shortfall Copyright (c) 2009 Prentice Hall. All rights reserved. 17

Treasury Stock Journal Entries: Sale Below Cost Situation 1 – Paid-in capital from treasury stock has a sufficient balance to cover the shortfall GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Cash Paid-in capital from treasury stock transactions Treasury stock (at cost) Copyright (c) 2009 Prentice Hall. All rights reserved. 18

Treasury Stock Journal Entries: Sale Below Cost Situation 2 – Paid-in capital from treasury stock has a balance too small to cover shortfall GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Cash Paid-in capital from treasury stock transactions For amount that zeros out account Retained earnings Treasury stock (at cost) Copyright (c) 2009 Prentice Hall. All rights reserved. 19

Treasury Stock Journal Entries: Sale Below Cost Situation 3 – Paid-in capital from treasury stock has a zero balance GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Cash Retained earnings Treasury stock (at cost) Copyright (c) 2009 Prentice Hall. All rights reserved. 20

1. Which of the following is false regarding stock dividends? A. They decrease Retained earnings. B. They increase Paid-in capital. C. They do not affect total stockholders’ equity. D. All of the above are true. Copyright (c) 2009 Prentice Hall. All rights reserved.

4. How are cash dividends and stock dividends the same? A. Both reduce Retained earnings. B. Both result in a liability. C. Neither affect total stockholders’ equity. D. Both increase shares outstanding. Copyright (c) 2009 Prentice Hall. All rights reserved.

Learning Objective 4 Report restrictions on retained earnings

Restrictions and Appropriations of Retained Earnings Restrictions Requirement by lenders to maintain a minimum level of equity by limiting: ◦ payment of dividends ◦ purchases of treasury stock Reported in the notes to the financial statements Appropriations Restrictions on retained earnings recorded by formal journal entries Board of directors may designate purpose of appropriation Copyright (c) 2009 Prentice Hall. All rights reserved. 33

Learning Objective 5 Complete a corporate income statement including earnings per share

Any Corporation Income Statement Sales revenue Cost of goods sold Gross profit Operating expenses Operating income Other gains (losses) Income from continuing operations before income tax Income tax expense Income from continuing operations Discontinued operations, net of tax Income before extraordinary items Extraordinary loss, net of tax Net Income Copyright (c) 2009 Prentice Hall. All rights reserved. 35

Income from Continuing Operations Measures profitability of the ongoing operations Useful for making projections about future earnings Any Corporation Income Statement Sales revenue Cost of goods sold Gross profit Operating expenses Operating income Other gains (losses) Income from continuing operations before income tax Income tax expense Income from continuing operations Copyright (c) 2009 Prentice Hall. All rights reserved. 36

Discontinued Operations Segment of a business that has been sold ◦ Identifiable division of company Reported separately because they will not be around in the future Shown net of tax ◦ Gain - income tax expense = Gain, net of tax ◦ Loss - income tax savings = Loss, net of tax Copyright (c) 2009 Prentice Hall. All rights reserved. 38

Extraordinary Items Both unusual and infrequent Examples: ◦ Losses from natural disasters ◦ Foreign government takeover (expropriation) Reported net of income tax effect Copyright (c) 2009 Prentice Hall. All rights reserved. 39

Earnings Per Share (EPS) Most widely used business statistic Measures amount of net income for each share of common stock outstanding ◦ Issued shares – treasury shares = outstanding shares Key measure of success in business Copyright (c) 2009 Prentice Hall. All rights reserved. 40

Earnings per share Net income – preferred dividends Average number of common shares outstanding EPS figures are reported for: Income from continuing operations Income from discontinued operations Income before extraordinary items Extraordinary gains or losses Net Income (loss) Copyright (c) 2009 Prentice Hall. All rights reserved. 41

Exercise 12 -21 (continued) Average number of common shares outstanding 52, 000 shares issued 2, 000 treasury shares 50, 000 common shares outstanding Copyright (c) 2009 Prentice Hall. All rights reserved. 43

Prior Period Adjustments Corrections to Retained earnings for errors of an earlier period Correcting entry includes ◦ Debit or credit to Retained earnings for error amount ◦ Debit or credit to asset or liability account that was misstated Reported on Statement of retained earnings Copyright (c) 2009 Prentice Hall. All rights reserved. 46

Comprehensive Income Change in total stockholders’ equity from all sources other than from its owners Net income plus or minus ◦ Unrealized gains/losses on certain investments ◦ Foreign currency translation adjustments Copyright (c) 2009 Prentice Hall. All rights reserved. 47

6. Outstanding shares equal: A. authorized shares – issued shares. B. issued shares – treasury shares. C. treasury shares – issued shares. D. authorized shares – treasury shares. Copyright (c) 2009 Prentice Hall. All rights reserved.

7. If treasury stock is sold above cost, which account is credited for the excess? A. Paid-in capital in excess of par B. Gain on sale of treasury stock C. Retained earnings D. Paid-in capital from treasury stock transactions Copyright (c) 2009 Prentice Hall. All rights reserved.

8. Retained earnings restrictions: A. are reported in the notes to the financial statements. B. limit amount that can be paid as dividends. C. are often the result of a requirement by lenders. D. include all of the above. Copyright (c) 2009 Prentice Hall. All rights reserved.

9. Which of the following income statement amounts provides the best predictor of future earnings? A. Income from continuing operations B. Income before extraordinary items C. Net income D. Any of the above Copyright (c) 2009 Prentice Hall. All rights reserved.

10. Which of the following are reported net of income tax effect? A. Gain on sale of plant assets B. Discontinued operations C. Interest expense D. All of the above Copyright (c) 2009 Prentice Hall. All rights reserved.

11. Which of the following would be considered an extraordinary item? A. Effects of an employee strike B. Sale of a business segment at a substantial loss C. Losses from a natural disaster D. Gain from early debt payment Copyright (c) 2009 Prentice Hall. All rights reserved.

12. A correction to Retained earnings of an error made previously is called a(n): A. extraordinary item. B. discontinued operation. C. prior period adjustment. D. retained earnings restatement. Copyright (c) 2009 Prentice Hall. All rights reserved.

End of Chapter 12