Copyright © 2007 Prentice-Hall. All rights reserved 1 Corporations: Retained Earnings and the Income Statement Chapter 12

Copyright © 2007 Prentice-Hall. All rights reserved 2 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 3 Objective 1 Account for stock dividends

Copyright © 2007 Prentice-Hall. All rights reserved 4 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 5 Entries for Stock Dividend Small Distribution is < % 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 6 E12-13E12-13 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 7 E12-13E12-13 USE MARKET VALUE 5,000 shares x $14 USE PAR Common stock = 5,000 shares x $1 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Apr30Retained Earnings70,000 Common Stock 5,000 Paid in Capital in Excess of Par, Common65,000

Copyright © 2007 Prentice-Hall. All rights reserved 8 E12-13E12-13 Stockholders’ Equity: Paid in Capital: Common stock, $1 par, 100,000 shares authorized, 55,000 shares issued$55,000 Paid in capital in excess of par265,000 Total paid in capital$320,000 Retained earnings ($120,000-70,000)50,000 Total stockholders’ equity$370,000 The number of shares issued increased. Retained earnings decreased Total stockholders’ equity is the same

Copyright © 2007 Prentice-Hall. All rights reserved 9 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 10 E12-15E12-15 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT 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 11 E12-3E12-3 Stockholders’ Equity: Paid in Capital: Common stock, $0.50 par, 400,000 shares authorized, 100,000 shares issued$50,000 Paid in capital in excess of par100,000 Total paid in capital$150,000 Retained earnings200,000 Total stockholders’ equity$350,000 Par value is cut in half None of the amounts in the accounts have changed Shares authorized and issued are double

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

Copyright © 2007 Prentice-Hall. All rights reserved 13 Comparison: Stock Dividends & Stock Splits Stock Dividend: Shifts amounts from retained earnings to paid- in 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 14 Objective 3 Account for treasury stock

Copyright © 2007 Prentice-Hall. All rights reserved 15 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 16 E12-17E12-17 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Feb4Cash200,000 Common Stock20,000 Paid in Capital in Excess of Par, Common180,000 Apr22Treasury Stock14,000 Cash14,000 Contra Equity Account

Copyright © 2007 Prentice-Hall. All rights reserved 17 E12-17E12-17 GENERAL JOURNAL DATEDESCRIPTIONREFDEBITCREDIT Aug22Cash12,000 Treasury Stock8,400 Paid in Capital from Treasury Stock Transactions3,600

Copyright © 2007 Prentice-Hall. All rights reserved 18 E12-17E12-17 Common Stock Paid in Capital In Excess of Par, Common Paid in Capital from Treasury Stock Transactions Retained EarningsTreasury Stock 20,000180,000 14, ,000* *Assumed 8,400 3,600 5,600

Copyright © 2007 Prentice-Hall. All rights reserved 19 *Assumed 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, Common180,000 Paid in Capital from Treasury Stock Transactions3,600 Total Paid in Capital$203,600 Retained Earnings100,000 Subtotal$303,600 Less Treasury Stock (400 shares at cost)5,600 Total Stockholders’ Equity$298,000

Copyright © 2007 Prentice-Hall. All rights reserved 20 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 21 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 22 Objective 4 Report restrictions on retained earnings

Copyright © 2007 Prentice-Hall. All rights reserved 23 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 24 E12-19 a Stockholders’ equity: Common stock, no par$50,000 Retained earnings—Note X 250,000 Total stockholders’ equity$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 25 E12-19 b Stockholders’ equity: Total paid-in capital$50,000 Retained earnings: Appropriated for debt agreement$100,000 Unappropriated 150,000 Total retained earnings 250,000 Total stockholders’ equity$300,000

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

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

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

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

Copyright © 2007 Prentice-Hall. All rights reserved 30 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 31 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 32 Conner Photographic Supplies, Inc. 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 savings20,000(30,000) Income before extraordinary items $40,000 Extraordinary loss$(15,000) Income tax savings6,000(9,000) Net income$31,000 E12-20E12-20

Copyright © 2007 Prentice-Hall. All rights reserved 33 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 34 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 35 E12-21E12-21 $108,000 – (1,000 x 6% x $50) (52,000 shares – 2,000 shares) =$105,000 / 50,000 shares =$2.10 Net income - Preferred dividends Average number of common shares outstanding Remember: Treasury stock is not considered outstanding

Copyright © 2007 Prentice-Hall. All rights reserved 36 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 E12-22E12-22 Preferred dividends:10,000  $10 .05 = $5,000

Copyright © 2007 Prentice-Hall. All rights reserved 37 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 38 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 39 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 40 E12-24E12-24 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 adjusted34,000 Net income for ,000 Subtotal104,000 Dividends for 2003 (24,000) Retained earnings, December 31, 2003$80,000

Copyright © 2007 Prentice-Hall. All rights reserved 41 End of Chapter 12