1. Prepared by: Debbie Musil Kwantlen University College
Chapter Corporations: Dividends, Retained Earnings and Income Reporting
Prepared by:
Debbie Musil
Kwantlen University College

2. Agenda
Learning goals
Vocabulary

3. Learning goals
Prepare the entries for cash dividends, stock dividends, and stock splits, and compare their financial impact
Prepare a corporate income statement
Prepare a statement of retained earnings
Evaluate earnings and dividends performance.

4. Vocabulary Basic earnings per share Interperiod tax allocation
Cash dividend
Intraperiod tax allocation
Change in accounting principle
Payment date
Comprehensive income statement
Payout ratio
Price-earning ratio (P/E)
Correction of a prior period error
Record date
Retained earnings restrictions
Debt covenant
Statement of retained earnings
Declaration date
Stock dividend
Dividend
Stock split
Earnings per share (EPS)
Weighted average number of shares
Fully diluted earnings per share

5. Cash Dividends Cash dividend distribution of cash to shareholders
To pay dividends, a corporation must:
Have enough retained earnings and
cash
Declare a dividend payable
Declaration date:
Board of directors formally declares dividend
Commits company to a legal obligation
Declaration is recorded:

6. Cash Dividends 2 Record date: Payment date:
Ownership of shares is determined
Shareholders of record on this date will receive dividend
No journal entry required
Payment date:
Dividend is paid to shareholders and recorded:

7. Stock Dividends Cash dividend Stock dividend Paid in cash
Decreases assets and shareholder’s equity
Paid in shares
No change in assets or shareholders’ equity
Decreases R/E and increases share capital
Doesn’t change your % ownership

8. Stock Dividends 2
Stock dividend neither increases nor decreases the assets in the company, investors are not receiving anything they did not already own.

9. Stock Dividends 2 Reasons for issuing stock dividends:
Satisfies shareholders' dividend expectations without spending cash
Decrease the price of shares making them more affordable
Emphasizes that a portion of shareholders’ equity has been permanently retained in the business
Therefore unavailable for cash dividends

10. Entries for Stock Dividends
Declaration date:
Issue (payment) date:

11. Equity Section after Stock Dividend

12. Stock Splits Involves the issue of additional shares to shareholders
Similar to a stock dividend
Increases the marketability of shares by lowering market value per share
Effect on share price is generally inversely proportional to size of split
Two – for – one stock split will decrease the stock price by 50%
Does not affect shareholders’ equity
Therefore no entries are required

13. Instead of a 10% stock dividend there was a two for one stock split
Stock Splits 2
Instead of a 10% stock dividend there was a two for one stock split

14. Comparison of Dividends and Stock Splits
Cash dividends reduce assets and shareholders’ equity (retained earnings)
Stock dividends increase share capital and decrease retained earnings
Stock dividends have no effect (but do increase number of shares issued)

15. Check for understanding
Sing CD Corporation has had five years of record earnings. Due to this success, the market price of its 500,000 common shares tripled from $15 to $45 per share. During this period, the Common Shares account remained the same at $2million. R/E increased from $1.5 million to $10 million. President Bill Zerter is considering either ( a 10% stock dividend or (2) a two-for-one stock split. He asked you to show the before and after effects of each option on the accounts Common Shares and Retained Earnings and on the number of shares. (719)

16. Practice questions
Self study 1-3
Questions 1, 4
BE14-15
E14-12

17. Corporate Income Taxes
Income statement for corporations are the same as proprietorship or a partnership
Major difference is income taxes
Since corporation is a separate legal entity
Affects income statement (income tax expense) and balance sheet (income tax payable)

18. Corporate Income Taxes 2
After a company determines its total income tax payable at year-end, it compares this amount to the total income tax instalments paid during the year. The difference between the income tax paid and income tax payable results in either an additional amount payable or a refund.

19. Corporate Income Taxes 3
Assume Leads had originally estimated that its taxable income would be $140,000. It has a 30% income tax rate, so its income tax was anticipated to be $42,000 ($140,000*30%). Leads remitted monthly instalments in the amount of $3,500 ($42,000/12). At year end, Leads actually reports taxable income of $156,000. Its total income tax liability is $46,800, and not $42,000 as estimated. Assuming it has already recorded and remitted $42,000 of income tax, the required adjustment entry is for $4,800
Dec. 31 Income Tax Expense 4,800
Income Tax Payable 4,800

20. Corporate Income Taxes 2
Interperiod tax allocation: Dividing income tax between amounts payable now and payable later
Intraperiod tax allocation: Associating income taxes in a period with their related items of income

21. Comprehensive Income Statement
Additional statement required in certain circumstances (R/E statement, income, balance sheet and cash flow statement)
An expansion of the subsection of the Equity section for other and Comprehensive Income
Includes all increases and decreases in shareholders’ equity except from share and dividend transactions

22. Retained Earnings
The cumulative total of income less losses and less declared dividends since incorporation
Represents part of shareholder’s claim on total assets of a corporation
Not a claim on any specific asset (including cash)
It would not be smart for a company to pay dividend = R/E. But there are restrictions to limit that :
Contractual restrictions such as debt covenants
Voluntary restrictions imposed by the Board of Directors

23. Prior Period Adjustments
A prior period adjustment results from:
the correction of a material error in reporting net income in a prior year, or
the changing of an accounting principle
Accounting treatment:
Use corrected amount or new principle in reporting results for the current year
Disclose cumulative effect of correction/change as an adjustment to retained earnings, not on income statement
Correct/restate financial statements for prior periods
Disclose effect of change in financial statements

24. Correction of Prior Period Errors
Correction is made directly to retained earnings
Since effect of error is now located there (all revenues and expenses have been closed to retained earnings)
Any corrections are net of any income tax effect
Example: overstatement of cost of goods sold
Understatement of inventory, net income (now retained earnings), and income tax payable

25. Correction of Prior Period Errors
Graber Inc, discovers in 2008 that is overstated its cost of goods sold in 2007 by $10,000 as a results of errors in counting inventory. Because costs of goods sold was overstated income before income tax was understated by the same amount, $10,000. If we assume an income tax rate of 30%, income tax expense would also be understated, but by $3,000 ($10,000*30%). The overall affect on net income is to understate it by $7,000 ($10,000-$3,000). In other words, net income is understated by the difference after tax [$10,000 *(100%-30%)]. If net income is understated, then R/E would also be understated by the same amount $7,000

26. Correction of Prior Period Errors

27. Change in Accounting Principle
Occurs when the principle used in current year is different that that used in prior year
May be voluntary or prescribed (by the CICA)
Usually applied retroactively (prior years restated) unless not practical to do so
Comparative amounts are restated
Retained earnings is adjusted, net of tax
Similar to adjustment for correction of errors

28. Reporting of Prior Period Adjustments
Reported in the statement of retained earnings
Adjustment is added to (subtracted from) opening balance of retained earnings, net of income tax effect
Financial statements of prior years are restated to reflect the change

29. Reporting of Prior Period Adjustments
Beginning of 2008 Graber changes from straight-line method of amortization for equipment to the declining-balance method. The equipment was purchased on January 2, The cumulative effect of this change is to increase amortization expense and accumulated amortization by $24,000 for the year of Amortization expense increase  reduces net income  reducing R/E

30. Reporting of Prior Period Adjustments
Jan. 2 Income Tax Payable
Retained Earnings 16,800
Accumulated Amortization 24,000
To record retroactive effect of change in amortization method

31. Sample Statement of Retained Earnings

32. Statement of Retained Earnings
Shows the changes in retained earnings during the year
Transactions that affect retained earnings:

33. Sample Statement of Retained Earnings

34. Check for understanding?
Vega Corporation reported retained earnings of $5,130,000 at December 31, In 2008, the company earns $2,000,000 of net income. It declares and pays a $250,000 cash dividend. Vega also records a pre-tax adjustment of $275,000 for an overstatement resulting from a mathematical error that affected 2007 ending inventory. The company also incurred a $25,500 change to retained earnings for the reacquisition of common shares. Its income tax rate is 30%. Prepare a statement of retained earnings for the year ended December 31. (727)

35. Practice Questions Self-study 4+7 Question 7+9+11+13 BE 14-610

36. Earnings Performance: Earnings per Share
Indicates net income earned by each common share
Reported on the income statement
Formula to calculate:
Weighted average number of common shares = shares issued during the year x the fraction of the year they are outstanding
Example: April 1 = 3/12 months if calendar year used
Net income less Preferred Dividends
Weighted Average Number of Common Shares
Earnings per Share ÷ =

37. Earnings Performance: Earnings per Share
Assume that a company has 100,000 common shares on January1, and issued an additional 10,000 shares on October 1. The weighted average number of share for the year would be calculated as follows:

38. Earnings per Share: Complex Share Structures
When a company has securities that can be converted into common shares
Example: convertible preferred shares
If converted, the additional common shares will result in a reduced (diluted) EPS figure
Two EPS amounts are calculated:
Basic EPS: as regular EPS formula from previous slide
Fully diluted EPS: calculated as if all securities were converted into common shares

39. Earnings Performance: Price-Earnings Ratio
Helps investors compare earnings of different companies
Formula to calculate:
A high PE ratio is an indicator that investors believe the company has good earnings potential
P/E ratio of 34 means that the shares are trading 24 times it’s earnings.
Market Price per Share
Earnings per Share
Price-Earnings Ratio ÷ =

40. Payout Ratio
Indicates what percentage of earnings a company is distributing to its shareholders
Can be calculated for both common and preferred shares:
Payout ratios vary with the industry
High payout ratios can indicate that a company is not reinvesting enough in its operations
Cash Dividends
Payout Ratio ÷ =
Net income

41. Check for understanding
Shoten Limited reported net income of $249,750 on its October 31, year-end income statement. The shareholders’ equity section of its balance sheet reported 3,000 $2-noncumulative preferred shares and 50,000 common shares. Of the common shares, 40,000 had been issued since the beginning of years, 15,000 were issued on March 1, and 5,000 were repurchased on August 1. The preferred dividend was declared and paid during the year. Calculate Shoten’s earnings per share. (731)

42. Practice Questions
Self study questions 8-10
BE 14-1114 E