College Accounting, by Heintz and Parry Chapter 22: Corporations: Earnings and Distributions

When Nick had more time to think about making the business a corporation, he had more questions. “How does this corporate income tax work? Do we turn money in with our payroll taxes, or do we pay at the end of the year when we know what our income is?” “Neither. You estimate your income and your income tax and pay 1/4 of the tax estimate on a quarterly basis. Then, just like an individual taxpayer, you send in a return at the end of the year and either pay the rest of what you owe or request a refund. The estimated payments are due on April 15, June 15, September 15, and December 15. The tax return deadline is March 15. Let’s assume you estimate income taxes of $88,000 for your first year.” Question: What accounts would be debited and credited (and for what amounts) when the first payment was made on April 15th?

Answer: “The entry is shown below. The same entry would be made on the fifteenth of June, September, and December. Date Description P. R. Debit Credit 2002 Apr. 15 Income Tax Expense ($88,000/4) 22, Cash 22, Now let’s assume that you calculate your 2002 taxes in January of 2003 and they are $93,000 for the full year of 2002.” Question: What accounts would be debited and credited (and for what amounts) for the balance owed for the year ending Dec. 31, 2002?

Answer: “The entry is shown below. The amount is calculated by subtracting the $88,000 total of the quarterly payments from the $93,000 final calculation of income tax. Date Description P. R. Debit Credit 2002 Dec. 31 Income Tax Expense 5, Income Tax Payable 5, On March 15, 2003, the payment of the $5,000 will involve a debit to Income Tax Payable and a credit to cash.” “That’s great, Eddie, thanks. Now can you explain how the account retained earnings works?” “Retained earnings is just what it says: earnings of the business retained by the company and not distributed to the owners.” Question: What is the only entry that generally increases retained earnings?

Answer: “The entry is the closing entry for income summary. This entry would be reversed if the company had a net loss, of course.” Date Description P. R. Debit Credit 2002 Dec. 31 Income Summary 75, Retained Earnings 75, Eddie had another question for Nick: Question: ”What type of transaction most commonly decreases retained earnings?”

Answer: “I know this one. It’s the declaration of dividends.” “Yes. For example, let’s say we declare our standard $3 dividend on our 5,000 shares of preferred stock, and a $.50 per share dividend on our 20,000 shares of common stock. On the declaration date, we’ve established a legal liability, so we make these entries.” Date Description P. R. Debit Credit 2003 Feb. 15 Retained Earnings 15, Preferred Dividends Payable 15, Feb. 15 Retained Earnings 10, Common Dividends Payable 10, These dividends will be paid to stockholders on the date of record. This date determines who gets the dividend if shares are sold between the date of declaration and the payment date.” Question: What are the entries on the payment date?

Answer: “I know this one, too. After a while, you get the idea that paying off a liability with cash always works the same way. Let me write it down for you.” Date Description P. R. Debit Credit 2003 Mar. 15 Preferred Dividends Payable 15, Cash 15, Mar. 15 Common Dividends Payable 10, Cash 10, ”Very nice, Nick. You may have earned your junior accountant’s badge. First, though, answer a tougher one. Let’s say we declare a 10% stock dividend (1 new share given out for every 10 shares currently owned). Currently, we have 20,000 shares outstanding with a par value of $2 and a market value of $11.” Question: What is the entry on the date of declaration?

Answer: “The key is that the transaction is booked at market value for a stock dividend of less than 20-25%. A stockholders’ equity account called Stock Dividends Distributable would be opened temporarily.” Date Description P. R. Debit Credit 2003 Feb. 15 Retained Earnings (2,000 shares X $11 market value) 22, Stock Dividends Distributable (2,000 shares X $2 par value) 4, Paid-In Capital in Excess of Par- Common Stock ($22,000 - $4,000) 18, ”By the way, if the stock dividend were more than 20-25%, the transaction would be booked at par value instead of market value, and the account ‘Paid-In Capital in Excess of Par Value’ wouldn’t be involved.” Question: What is the entry on the date of distribution?

Answer: “The Stock Dividends Distributable would become common stock of the corporation.” Date Description P. R. Debit Credit 2003 Feb. 15 Stock Dividends Distributable (2,000 shares X $2 par value) 4, Common Stock 4, ”A corporation can also give more shares to its stockholders by declaring a stock split. In our example, the company could replace the 20,000 shares of $2 par stock with 40,000 shares of $1 par stock (a two-for-one split). Total par value of $40,000 is unchanged, but the shares may be easier to sell (because the market value of a share may become more affordable). Question: What is the entry when a stock split is declared?

Answer: “I don’t know, Eddie.” “Of course not. It was a trick question. There is no entry, just a memo notation describing the difference in number of shares and par value per share.” Date Description P. R. Debit Credit 2003 Mar. 15 Declared a two-for-one stock split. Exchanged 40,000 shares of $1 par common stock for 20,000 shares of $2 par common stock. “Another thing that can affect retained earnings is for the board of directors to make an appropriation of retained earnings. For example, $200,000 could be set aside to pay a bank loan. The new account “Retained Earnings Appropriated for Bank Loan” can not be used to pay dividends, so the total amount of dividends is limited.” Question: What is the entry when this appropriation of retained earnings is made?

Answer: “Here is the entry.” Date Description P. R. Debit Credit 2003 Mar. 15 Retained Earnings 200, Retained Earnings Appropriated for Bank Loan 200, ”The entry would be reversed once the loan was paid off. If you don’t have an appropriation, you can do a Statement of Retained Earnings that is very simple and very similar to the Statement of Owners’ Equity we’ve done up until now.”

“The statement would look like this.” “Man, accounting for retained earnings is easy. The hard part is the earning and retaining.” “I heard that. Let’s get out of this office and help some customers.” The CD Side of Town Statement of Retained Earnings For Year Ended Dec. 31, 2002 Retained Earnings, Jan. 1 $120,000 Add net income for the year 75, ,000 Less: Cash Dividends $25,000 Stock Dividends 22,000 47,000 Retained Earnings, Dec. 31 $148,000