Corporations Retained Earnings and the Income Statement Chapter

Corporations: Retained Earnings and the Income Statement Chapter 14 Copyright © 2007 Prentice-Hall. All rights reserved 1

Retained Earnings • All net income minus net losses minus dividends • Negative balance in Retained Earnings deficit • Not a fund of cash Copyright © 2007 Prentice-Hall. All rights reserved 2

Objective 1 Account for stock dividends Copyright © 2007 Prentice-Hall. All rights reserved 3

Stock Dividend • Proportional distribution of corporation’s own stock to shareholders • Does not change total stockholders’ equity • Transfer of retained earnings to contributed capital – no assets are distributed Copyright © 2007 Prentice-Hall. All rights reserved 4

Entries for Stock Dividend Small • Distribution is < 2025% of previously outstanding shares • Debit retained earnings for market value of shares to be distributed Large • Distribution is > 25% of previously outstanding shares • Debit retained earnings for par or stated value of shares Copyright © 2007 Prentice-Hall. All rights reserved 5

E 14 -13 How many shares of stock are distributed? 50, 000 × 10% = 5, 000 shares How much will be debited to retained earnings? 5, 000 shares x $14 = $70, 000 Copyright © 2007 Prentice-Hall. All rights reserved 6

E 14 -13 GENERAL JOURNAL DATE Apr DESCRIPTION REF 30 Retained Earnings Common Stock 5, 000 Paid in Capital in Excess of Par, Common 65, 000 DEBIT CREDIT 70, 000 USE MARKET VALUE USE PAR 5, 000 shares x $14 Common stock = 5, 000 shares x $1 Copyright © 2007 Prentice-Hall. All rights reserved 7

E 14 -13 The number of shares Retained earnings decreased issued increased. Stockholders’ Equity: Paid in Capital: Common stock, $1 par, 100, 000 shares authorized, 55, 000 shares issued Total stockholders’ equity is Paid in capital the in excess same of par Total paid in capital Retained earnings ($120, 000 -70, 000) Total stockholders’ equity Copyright © 2007 Prentice-Hall. All rights reserved $55, 000 265, 000 $320, 000 50, 000 $370, 000 8

Stock Splits • Increases the number of shares authorized, issued and outstanding • Decreased par value per share • Balances in the accounts are unchanged • Record in a memorandum entry Copyright © 2007 Prentice-Hall. All rights reserved 9

E 14 -15 GENERAL JOURNAL DATE DESCRIPTION REF DEBIT CREDIT Jun 30 Called in the outstanding $1 par common stock and distributed 2 shares of $0. 50 par common stock for each old. There are now 100, 000 shares outstanding. Copyright © 2007 Prentice-Hall. All rights reserved 10

E 14 -3 Shares authorized and issued Par value is cut in half are double Stockholders’ Equity: Paid in Capital: Common stock, $0. 50 par, 400, 000 shares authorized, 100, 000 shares issued Paid in capital in excess of par Total paid in capital Retained earnings Total stockholders’ equity None of the amounts in the accounts have changed Copyright © 2007 Prentice-Hall. All rights reserved $50, 000 100, 000 $150, 000 200, 000 $350, 000 11

Objective 2 Distinguish stock splits from stock dividends Copyright © 2007 Prentice-Hall. All rights reserved 12

Comparison: Stock Dividends & Stock Splits Stock Dividend: • Shifts amounts from retained earnings to paidin capital • Par value per share remains unchanged • Number of shares issued increases • Total stockholders’ equity does not change Stock Split: • Account balances do not change • Par value decreases • Number of shares of stock authorized, issued, and outstanding increase • Total stockholders’ equity does not change Copyright © 2007 Prentice-Hall. All rights reserved 13

Objective 3 Account for treasury stock Copyright © 2007 Prentice-Hall. All rights reserved 14

Treasury Stock • Shares that a company has issued and later reacquired • Purchasing treasury stock decreases assets and stockholders’ equity • Contra equity account • Record at cost • Report after retained earnings on balance sheet Copyright © 2007 Prentice-Hall. All rights reserved 15

E 14 -17 GENERAL JOURNAL DATE Feb DESCRIPTION 4 Cash Common Stock 20, 000 Paid in Capital in Excess of Par, Common 180, 000 Apr 22 Treasury Stock Cash 14, 000 Contra Equity Account Copyright © 2007 Prentice-Hall. All rights reserved REF DEBIT CREDIT 200, 000 14, 000 16

E 14 -17 GENERAL JOURNAL DATE DESCRIPTION Aug 22 Cash Treasury Stock 8, 400 Paid in Capital from Treasury Stock Transactions 3, 600 Copyright © 2007 Prentice-Hall. All rights reserved REF DEBIT CREDIT 12, 000 17

E 14 -17 Common Stock Paid in Capital In Excess of Par, from Treasury Common Stock Transactions 20, 000 180, 000 Retained Earnings 100, 000* 3, 600 Treasury Stock 14, 000 8, 400 5, 600 *Assumed Copyright © 2007 Prentice-Hall. All rights reserved 18

Austin Driving School, Inc. Partial Balance Sheet December 31, 2008 Stockholders’ Equity Paid in Capital: Common Stock $20, 000 Paid in Capital in Excess of Par, Common Paid in Capital from Treasury Stock Transactions 3, 600 Total Paid in Capital $203, 600 Retained Earnings 100, 000 Subtotal $303, 600 Less Treasury Stock (400 shares at cost) Total Stockholders’ Equity $298, 000 180, 000 5, 600 *Assumed Copyright © 2007 Prentice-Hall. All rights reserved 19

Shares Issued & Outstanding • Issued shares – number of shares sold • Outstanding shares – number of shares in the hands of stockholders • Treasury stock decreases the number of shares outstanding • Treasury stock does not receive dividends In the previous example, then, the number of shares issued are 20, 000. The number of shares outstanding are 19, 600 (20, 000 – 400 shares in treasury) Copyright © 2007 Prentice-Hall. All rights reserved 20

Retirement of Stock • Decreases outstanding stock • Retired shares cannot be reissued • Remove stock from books – Debit stock accounts – Credit cash Copyright © 2007 Prentice-Hall. All rights reserved 21

Objective 4 Report restrictions on retained earnings Copyright © 2007 Prentice-Hall. All rights reserved 22

Restrictions on Retained Earnings • Reported in notes to financial statements • Restricts amount of retained earnings available for dividends • Appropriations are restrictions on retained earnings recorded by formal journal entries Copyright © 2007 Prentice-Hall. All rights reserved 23

E 14 -19 a Stockholders’ equity: Common stock, no par Retained earnings—Note X Total stockholders’ equity $50, 000 250, 000 $300, 000 Note X— Long-term debt (or Restriction of retained earnings). The company’s long-term debt agreement restricts retained earnings in the amount of $200, 000. Copyright © 2007 Prentice-Hall. All rights reserved 24

E 14 -19 b Stockholders’ equity: Total paid-in capital Retained earnings: Appropriated for debt agreement Unappropriated Total retained earnings Total stockholders’ equity $50, 000 $100, 000 150, 000 Copyright © 2007 Prentice-Hall. All rights reserved 250, 000 $300, 000 25

Objective 5 Analyze a corporate income statement Copyright © 2007 Prentice-Hall. All rights reserved 26

Corporate Income Statement Continuing Operations Special Items Earnings Per Share Normal operating revenues and expenses, including income tax expense Items that are material in amount, but are not typical of regular operations Amount of net income for each share of outstanding common stock Copyright © 2007 Prentice-Hall. All rights reserved 27

Income from Continuing Operations • Measures profitability of the ongoing operations • Useful for making projections about future earnings Copyright © 2007 Prentice-Hall. All rights reserved 28

Special Items • Reported after income from continuing operations – Discontinued operations – Extraordinary gains and losses Copyright © 2007 Prentice-Hall. All rights reserved 29

Discontinued Operations • Segment of a business that has been sold • Two parts – Income or loss from operations of business from beginning of year to date of disposal – Gain or loss on disposal of the assets of the segment – Reported net of the income tax effect Copyright © 2007 Prentice-Hall. All rights reserved 30

Extraordinary Items • Both unusual and infrequent – Unusual in nature – abnormal and only incidentally related to customary activities – Infrequent in occurrence – not reasonably expected to happen in the foreseeable future • Reported net of income tax effect Copyright © 2007 Prentice-Hall. All rights reserved 31

E 14 -20 Conner Photographic Supplies, Income Statement Year Ended December 31, 2008 Sales revenue $430, 000 Cost of goods sold (240, 000) Gross profit $190, 000 Operating expenses (120, 000) Income from continuing operations $70, 000 Loss on discontinued operations $(50, 000) Income tax savings 20, 000 (30, 000) 32 Copyright © 2007 Prentice-Hall. All rights reserved

Earnings Per Share Net income - Preferred dividends Average number of common shares outstanding Report separate EPS figures for each line on income statement starting with income from continuing operations though to net income Copyright © 2007 Prentice-Hall. All rights reserved 33

Earnings Per Share and Preferred Stock Corporations with complex capital structures present two sets of EPS amounts • Basic EPS • Diluted EPS Copyright © 2007 Prentice-Hall. All rights reserved 34

E 14 -21 Net income - Preferred dividends Average number of common shares outstanding = = $108, 000 – (1, 000 x 6% x $50) (52, 000 shares – 2, 000 shares) $105, 000 / 50, 000 shares $2. 10 Remember: Treasury stock is not considered outstanding Copyright © 2007 Prentice-Hall. All rights reserved 35

E 14 -22 Preferred dividends: 10, 000 $10 . 05 = $5, 000 Earnings per share: Income from continuing operations [($110, 000 – $5, 000) / 50, 000] $2. 10 Loss on discontinued operations ($8, 000 / 50, 000) (. 16) Income before extraordinary items [($102, 000 – $5, 000) / 50, 000] $1. 94 Extraordinary gain ($20, 000 / 50, 000). 40 Net income [($122, 000 – $5, 000) / 50, 000] $2. 34 Copyright © 2007 Prentice-Hall. All rights reserved 36

Statement of Retained Earnings • Reports how retained earnings changed over the accounting period • Beginning balance + net income – dividends = Ending balance Copyright © 2007 Prentice-Hall. All rights reserved 37

Comprehensive Income • Change in total stockholders’ equity from all sources other than from its owners – Net income – Unrealized gains/losses on certain investments – Foreign currency translation adjustments Copyright © 2007 Prentice-Hall. All rights reserved 38

Prior Period Adjustments • Corrections to beginning balance of 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 © 2007 Prentice-Hall. All rights reserved 39

E 14 -24 Sarah Lou Bakery, Inc. Statement of Retained Earnings Year Ended December 31, 2003 Millions Retained earnings, December 31, 2002, as originally reported $39, 000 Prior period adjustment (5, 000) Retained earnings, December 31, 2002, as adjusted 34, 000 Net income for 2003 70, 000 Subtotal 104, 000 Dividends for 2003 (24, 000) Retained earnings, December 31, 2003 $80, 000 Copyright © 2007 Prentice-Hall. All rights reserved 40

End of Chapter 14 Copyright © 2007 Prentice-Hall. All rights reserved 41