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Introduction to Accounting 2 Modul 7 Chapter 15
CORPORATIONS: Dividends, Retained Earnings, and Income Reporting
After studying this chapter, you should be able to:
- Prepare the entries for cash dividends and stock dividends.
- Identify the items that are reported in a retained earnings statement.
- Prepare and analyze a comprehensive stockholdersโ equity section.
- Describe the form and content of corporation income statements.
- Compute earnings per share.
DIVIDENDS (STUDY OBJECTIVE 1)
๏ท Distribution by a corporation to its stockholders on a pro rata (proportional) basis ๏ท May be in the form of cash, property, scrip (promissory note to pay cash), or stock ๏ท May be expressed in one of two ways:
- As a percentage of the par or stated value of the stock
- As a dollar amount per share
Cash Dividends
๏ท For a corporation to pay a cash dividend it must have: a. Retained earnings b. Adequate cash c. A declaration of dividends
Entries for Cash Dividends
Three important dates in connection with dividends:
๏ท Declaration date Board of Directors formally declares a cash dividend and a liability is recorded. ๏ท Record date Marks the time when ownership of outstanding shares is determined from the records maintained by the corporation. ๏ท Payment date Date dividend checks are mailed to the stockholders and the payment of the dividend is recorded.
Key Dividend Dates
Declaration Date
Assume that on December 1, 2005, 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 $50,000 (100,000 x 50 cents) and the entry to record the declaration is:
Record Date
The purpose of the record date is to identify the persons or entities that will receive the dividend, not to determine the dividend liability. For Media General, the record date is December 22. No entry is required on this date because the corporationโs liability recognized on the declaration date is unchanged.
Payment Date
Assuming the payment date is January 20 for Media General, the entry on that date is :
Allocating Cash Dividends Between Preferred and Common Stock
Total dividend $50, Allocated to preferred stock Dividend in arrears, 2005 (1,000 x $2) $2, 2006 dividend (1,000 x $8) 8, 10, Remainder allocated to common stock $40,
At December 31, 2005, IBR declares a $50,000 cash dividend. The allocation of the dividend to the two classes of stock is shown above.If the preferred stock was NON- cumulative, preferred stockholders would have received only $8,000 in dividends in 2006 and common stockholders would have received $42,000.
Stock Dividends
๏ท Pro rata distribution to stockholders of the corporationโs own stock ๏ผ Results in a decrease in retained earnings and an increase in paid-in capital ๏ผ At a minimum, the par or stated value must be assigned to the dividend shares; in most cases, however, fair market value is used ๏ท A stock dividend does NOT decrease Total Assets or Total Stockholdersโ Equity.
Disclosure
Rally would present the information in the following format.
Rally Inc. Income Statement (partial) Net income $211, Earnings per share $2.
Earnings per Share
The formula to compute earnings per share when there is no preferred stock is as follows:
๐๐๐ก ๐ผ๐๐๐๐๐ ๐๐๐๐ ๐๐ก๐๐ ๐ด๐ฃ๐๐๐๐๐ ๐ถ๐๐๐๐๐ ๐๐๐๐๐ ๐๐ข๐ก๐ ๐ก๐๐๐๐๐๐ = Earning Per Share
Purposes and Benefits of a Stock Dividend
Corporations issue stock dividends generally for one or more of the following reasons:
- To satisfy stockholdersโ dividend expectations without spending cash
- To increase the marketability of stock by increasing the number of shares
- To emphasize that a portion of stockholdersโ equity has been permanently reinvested in the business and unavailable for cash dividends
Stock Dividends Distinguished
๏ท SMALL stock dividend o Less than 20-25% of the corporationโs issued stock o Assign fair market value to small stock dividends Assumption that a small stock dividend will have little effect on the market price of the shares previously outstanding. ๏ท LARGE stock dividend o Greater than 20-25% of the corporationโs issued stock o Par or stated value per share is normally assigned
Entries for Stock Dividends
Assume that Medland Corporation has a balance of $300,000 in retained earnings and declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current fair value of its stock is $15 per share and the number of shares to be issued is 5,000 (10% of 50,000). The amount to be debited to Retained Earnings is $75,000 (5,000 x $15).
Stock Splits
๏ท The issuance of additional shares to stockholders according to their percentage ownership o Number of shares increased in the same proportion that par or stated value per share is decreased ๏ท Has no effect on total paid-in capital, retained earnings, and total stockholdersโ equity. ๏ท Not necessary to formally journalize a stock split
Stock Split Effects
Assume instead of a 10% dividend, Medland Corporation splits its 50,000 shares of common stock on a 2-for-1 basis. This means that one share of $10 par value stock is exchanged for two shares of $5 par value stock. A stock split DOES NOT have any effect on total paid-in capital, retained earnings, and total stockholdersโ equity. However, number of shares increases and book value per share decreases.
Differences Between the Effects of Stock Splits and Stock Dividends
RETAINED EARNINGS ( STUDY OBJECTIVE 2)
๏ท Net income retained in the business. ๏ท Balance in retained earnings is part of the stockholdersโ claim on the total assets of the corporation. o A net loss is recorded in Retained Earnings by a closing entry in which Retained Earnings is debited and Income Summary is credited_._
Stockholdersโ Equity with Deficit
A debit balance in retained earnings is identified as a DEFICIT. It is reported as a deduction in the stockholdersโ equity section, as shown above.
Retained Earnings Restrictions
๏ท Portion of the balance currently unavailable for dividends.
- Legal States may require that corporations restrict re for the cost of treasury stock purchased.
- Contractual Long term debt contracts may restrict re as a condition for a loan.
- Voluntary The board of directors may voluntarily restrict re for specific purposes such as future plant expansion.
Disclosure of Unrestricted Retained Earnings
๏ท The balance in retained earnings is generally available for dividend declarations. Some companies state this fact. ๏ท In the notes to its financial statements, Martin Lockheed Corporation states:
NOTE: REPORTING THE CORRECTION IN THE CURRENT YEARโS INCOME
STATEMENT WOULD BE INCORRECT BECAUSE IT APPLIES TO A PRIOR YEARโS
INCOME STATEMENT.
Debits and Credits to Retained Earnings
Retained Earnings
- Net Loss 1. Net income
- Prior period adjustments for overstatement of net income
2 Prior period adjustment for understatement of net income
- Cash dividends and stock dividends
- Some disposals of treasury stock
Many corporations prepare a retained earnings statement to explain the changes in retained earnings during the year.
COMPREHENSIVE STOCKHOLDERSโ EQUITY SECTION (STUDY OBJECTIVE 3)
๏ท Common Stock Dividends Distributable o Shown Under Capital Stock In Paid-In-Capital ๏ท Retained Earnings restrictions o Disclosed In The Notes To The Financial Statements
CORPORATION INCOME STATEMENTS (STUDY OBJECTIVE 4)
๏ท Includes essentially the same sections as in a proprietorship or a partnership except for the reporting of income taxes ๏ท For tax purposes, corporations are considered to be a separate legal entity. ๏ท Income tax expense o Reported in a separate section of the corporation income statement before net income
Income Statement with Income Taxes
Income Tax Expense
Using the preceding Income Statement, the adjusting entry for income tax expense at December 31, 2005, would be as follows:
EARNINGS PER SHARE (STUDY OBJECTIVE 5)
๏ท Frequently reported in the financial press ๏ท Used by stockholders and investors to evaluate profitability ๏ท Indicates the net income earned by each share of outstanding common stock
EPS and Preferred Stock Dividends
When a corporation has both preferred and common stock, the current yearโs dividend declared on preferred stock is subtracted from net income to arrive at income available to common stockholders. Assume that Rally Inc. reports net income of $211,000 on its 102,500 weighted average common shares. During the year it also declares a $6,000 dividend on its preferred stock.
๐๐๐ก ๐ผ๐๐๐๐๐ ๐๐๐๐ข๐ ๐๐๐๐๐๐๐๐ ๐๐๐ฃ๐๐๐๐๐ ๐๐๐๐ ๐๐ก๐๐ ๐ด๐ฃ๐๐๐๐๐ ๐ถ๐๐๐๐๐ ๐๐๐๐๐ ๐๐ข๐ก๐ ๐ก๐๐๐๐๐ ๐ = Earning Per Share
($211,000โ$6,000) 102,500 = $2 EPS
Therefore, Rally has $205,000 ($211,000 - $6,000) available for common stock dividends. EPS is $2 ($205,000 / 102,500).
REVIEW
- The date a cash dividend becomes a binding legal obligation to a corporation is the a. Declaration date. b. Earnings date. c. Payment date. d. Record date.
