CORPORATIONS: DIVIDENDS, RETAINED EARNINGS, AND INCOME REPORTING CHAPTER 14 CORPORATIONS: DIVIDENDS, RETAINED EARNINGS, AND INCOME REPORTING Accounting Principles, Eighth Edition

Study Objectives Prepare the entries for cash dividends and stock dividends. Identify the items reported in a retained earnings statement. Prepare and analyze a comprehensive stockholders’ equity section. Describe the form and content of corporation income statements. Compute earnings per share. 1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements? Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases). Forward-looking Information Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image). Timeliness (no real time financial information)

Corporations: Dividends, Retained Earnings, and Income Reporting Statement Presentation and Analysis Cash dividends Stock dividends Stock splits Retained earnings restrictions Prior period adjustments Retained earnings statement Stockholders’ Equity Presentation Stockholders’ Equity Analysis Income Statement Presentation Income Statement Analysis Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation. Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt. Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets. Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees. Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss: difference between the actual return and the expected return on plan assets and, amortization of the unrecognized net gain or loss from previous periods

Dividends A distribution of cash or stock to stockholders on a pro rata (proportional) basis. Types of Dividends: Cash dividends. Property dividends. Script (promissory note). Stock dividends. Dividends expressed: (1) as a percentage of the par or stated value, or (2) as a dollar amount per share. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Dividends require information concerning three dates: LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Cash Dividends For a corporation to pay a cash dividend, it must have: Retained earnings - Payment of cash dividends from retained earnings is legal in all states. Adequate cash. A declaration of dividends by the Board of Directors. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Illustration: What would be the journal entries made by a corporation that declared a $50,000 cash dividend on March 10, payable on April 6 to shareholders of record on March 25? March 10 (Declaration Date) Retained earnings 50,000 Dividends payable 50,000 March 25 (Date of Record) No entry April 6 (Payment Date) Dividends payable 50,000 Cash 50,000 LO 1 Prepare the entries for cash dividends and stock dividends.

Allocating Cash Dividends Between Preferred and Common Stock Holders of cumulative preferred stock must be paid any unpaid prior-year dividends before common stockholders receive dividends. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Exercise Arnez Corporation was organized on January 1, 2008. During its first year, the corporation issued 2,000 shares of $50 par value preferred stock and 100,000 shares of $10 par value common stock. At December 31, the company declared the following cash dividends: 2008, $6,000, 2009, $12,000, and 2010, $28,000. Instructions: (a) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 8% and not cumulative. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Exercise (a) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 8% and not cumulative. * * 2,000 shares x $50 par x 8% = $8,000 LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Exercise (b) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 9% and cumulative. ** * * 2,000 shares x $50 par x 9% = $9,000 ** 2008 Pfd. dividends $9,000 – declared $6,000 = $3,000 LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Exercise (c) Journalize the declaration of the cash dividend at December 31, 2010, under part (b). Journal entry: Retained earnings 28,000 Dividends payable 28,000 LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Stock Dividends Pro rata distribution of the corporation’s own stock. Illustration 14-3 Results in decrease in retained earnings and increase in paid-in capital. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Stock Dividends Reasons why corporations issue stock dividends: To satisfy stockholders’ dividend expectations without spending cash. To increase the marketability of the corporation’s stock. To emphasize that a portion of stockholders’ equity has been permanently reinvested in the business. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Size of Stock Dividends Small stock dividend (less than 20–25% of the corporation’s issued stock, recorded at fair market value) Large stock dividend (greater than 20–25% of issued stock, recorded at par value) * * This accounting is based on the assumption that a small stock dividend will have little effect on the market price of the outstanding shares. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Illustration: HH Inc. has 5,000 shares issued and outstanding. The per share par value is $1, book value $32 and market value is $40. 10% stock dividend is declared Retained earnings (5,000 x 10% x $40) 20,000 Common stock dividends distributable 500 Additional paid-in capital 19,500 Stock issued Common stock div. distributable 500 Common stock (5,000 x 10% x $1) 500 LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Stockholders’ Equity with Dividends Distributable LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Effects of Stock Dividends $ 0 $ 0 LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Stock Split Reduces the market value of shares. No entry recorded for a stock split. Decrease par value and increase number of shares. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Illustration: HH Inc. has 5,000 shares issued and outstanding. The per share par value is $1, book value $32 and market value is $40. 2 for 1 Stock Split No Entry -- Disclosure that par is now $.50 and shares outstanding are 10,000. LO 1 Prepare the entries for cash dividends and stock dividends.

Dividends Effects of Stock Dividends LO 1 Prepare the entries for cash dividends and stock dividends.

Retained Earnings Retained earnings is net income that a company retains for use in the business. Net income increases Retained Earnings and a net loss decreases Retained Earnings. Retained earnings is part of the stockholders’ claim on the total assets of the corporation. A debit balance in Retained Earnings is identified as a deficit. LO 2 Identify the items reported in a retained earnings statement.

Retained Earnings Restrictions Restrictions can result from: Legal restrictions. Contractual restrictions. Voluntary restrictions. Companies generally disclose retained earnings restrictions in the notes to the financial statements. LO 2 Identify the items reported in a retained earnings statement.

Prior Period Adjustments Corrections of Errors Result from: mathematical mistakes mistakes in application of accounting principles oversight or misuse of facts Corrections treated as prior period adjustments Adjustment made to the beginning balance of retained earnings LO 2 Identify the items reported in a retained earnings statement.

Retained Earnings Statement The company prepares the statement from the Retained Earnings account. Illustration 14-13 LO 2 Identify the items reported in a retained earnings statement.

Statement Analysis and Presentation Illustration 14-15 LO 3 Prepare and analyze a comprehensive stockholders’ equity section.

Return on Common Stockholders’ Equity Statement Analysis and Presentation Stockholders’ Equity Analysis Net Income Available to Common Stockholders Return on Common Stockholders’ Equity = Average Common Stockholders’ Equity This ratio shows how many dollars of net income the company earned for each dollar invested by the stockholders. LO 3 Prepare and analyze a comprehensive stockholders’ equity section.

Statement Analysis and Presentation Illustration 14-17 Income Statement Presentation LO 4 Describe the form and content of corporation income statements.

Statement Analysis and Presentation Income Statement Analysis Net Income minus Preferred Dividends Earnings Per Share = Weighted-Average Common Shares Outstanding This ratio indicates the net income earned by each share of outstanding common stock. LO 5 Compute Earnings Per Share.