2. Corporate Earnings and Capital Transactions
Chapter 21
Corporate Earnings and Capital Transactions
Section 1: Accounting
for Corporate Earnings
Section Objectives
Chapter 20 discussed formation of corporations and capital stock transactions. Chapter 21 continues with other corporate capital transactions such as earnings and income taxes. In this first section of chapter 21, a corporation’s required journal entries for federal income tax is discussed. In addition, the completion of the accounting cycle including the preparation of the worksheet, adjusting and closing journal entries and the preparation of the income statement is explained.
Estimate the federal corporate income tax and prepare related journal entries.
Complete a worksheet for a corporation.
Record corporate adjusting and closing entries.
Prepare an income statement for a corporation.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

3. Estimate the federal corporate income tax and prepare related journal entries
Objective 1
Corporate Income Tax
Recall that a disadvantage of the corporate form of business is that corporations must pay income taxes on profits.
Federal Income Tax Rates:
Taxable Income Tax Rate
First $ 50, %
Next $ 25, %
Next $ 25, %
Next $235, %
Over $335,000 See IRS publications for rates
A corporation estimates its taxable income by subtracting estimated expenses from estimated gross income. A corporation’s income tax liability is calculated by multiplying its estimated taxable income by the corporate income tax rate. Federal income tax rates are changed periodically by Congress but the rates shown here are what are used in the textbook.

4. Tax Estimates
Beginning of year: The corporation estimates the income tax expense for the coming year.
Quarterly: The corporation makes tax deposits based on the estimated tax expense.
April 15
June 15
September 15
December 15
End of year: The corporation recomputes the estimated income tax expense and compares it to the tax deposits made.
Corporations are required to estimate their income tax in advance and deposit one-fourth each quarter. The due dates are April 15, June 15, September 15, and December 15.
The journal entry would be:
Dr Income Tax Expense
Cr Cash

5. Tax Estimates
At the beginning of the year, Sports Outfitters Corporation estimated its tax liability for 2010 to be $35,976.
Sports Outfitters Corporation makes quarterly deposits during the year.
($35,976 ÷ 4 = $8,994)
At the beginning of the year, Sports Outfitters Corporation estimates their taxes. If the estimated tax for the year 2010 is $35,976, then ¼ of this amount would need to be paid to the IRS by April 15.
2010
Apr Income Tax Expense ,994.00
Cash ,994.00
Quarterly income tax
deposit.

6. New estimated tax expense $36,520 Quarterly tax deposits 35,976
At year-end, Sports Outfitters Corporation recomputes the estimated income tax expense and compares it to the tax deposits made during the year.
New estimated tax expense $36,520
Quarterly tax deposits ,976
At year-end, Sports Outfitters Corporation recomputes the estimated income tax expense and compares it to the tax deposits made during the year. An additional $544 of tax is estimated to be due.
Additional tax due $

7. Year-End Adjustment of Tax Liability
If the quarterly tax deposits are less than the end-of-year estimated tax expense, record the difference as follows:
Debit: Income Tax Expense
Credit: Income Tax Payable
If the quarterly tax deposits are greater than the end-of-year estimated tax expense, record the difference as follows:
Debit: Income Tax Refund Receivable
Credit: Income Tax Expense
Any difference in income tax due to the difference in taxable income and financial income is recorded in the Income Tax Expense account. An adjusting entry is made for either the refund due to the corporation or additional tax due at year-end.
In our example, the estimated deposits were less than the tax due at the end of the year by $544. In our adjusting journal entry, Income Tax Expense needs to be debited and Income Tax Payable needs to be credited for the additional tax.

8. Year-End Adjustment of Tax Liability
When books are closed at year-end, the income tax expense is re-computed.
The Income Tax Expense account is adjusted.
2010
Dec Income Tax Expense
Income Tax Payable
Estimate of additional tax due.
Here we see the adjusting journal entry required at year end. In this adjusting journal entry, the Income Tax Expense account is debited for the additional $544 of estimated income taxes owed in excess of the deposits already made.

9. Reporting Income Tax Expense on the Income Statement
There are two ways to show income tax expense on the income statement:
1. As a deduction at the bottom of the income statement.
2. As an operating expense, to emphasize that taxes represent a cost of doing business.
Income tax may be shown:
As a deduction from Net Income Before Income Tax at the bottom of the income statement, or
As an operating expense.

10. Deferred Income Taxes
Income reported on the financial statements does not usually match taxable income reported on the tax return.
Tax laws do not always follow generally accepted accounting principles:
Income or expenses can be included in taxable income this year and appear on the financial statements in later years, or vice versa.
Income or expenses can be included on the financial statements but never appear in taxable income.
Deferred income taxes are the amount of taxes that will be payable in the future. They result from a difference between taxable income and income for financial statement purposes.
Several accounting bodies—FASB, AICPA, AAA and others, establish accounting rules or generally accepted accounting principals (GAAP). Income reported on the financial statements may not agree with income reported on the tax return because tax laws do not always agree with GAAP.
However, although income is not reported in the current year, it may be taxable in the future. These future taxes are estimated to attempt to match the expense to the income on the financial statements. The adjustment includes:
Dr. Tax Expense
Cr Deferred Income Tax Liability.

11. Complete a worksheet for a corporation
Objective 2
Complete a worksheet for a corporation
How is preparing a worksheet for a corporation different from preparing one for a sole proprietorship?
QUESTION:
The worksheet for a corporation and a sole proprietorship are almost identical!
Objective 2 is to complete a worksheet for a corporation. This is very similar to worksheets we have competed in the past for sole proprietorships and partnerships. Remember, the purpose of the worksheet. (Saves time and effort, organizes all figures on one document, determines the effects of changes in accounts, and helps prepare financial statements more efficiently.)
Yeah. . except, when preparing a worksheet for a corporation, it is necessary to compute and show the income tax adjustment.

12. Corporate Worksheet Income Tax Adjustment
Total the Income Statement Columns before the adjustment for income tax.
Debit Credit
1,971, ,108,000
There are seven steps to complete a worksheet for a corporation.
Step 1 Enter the trial balance.
Step 2 Enter the adjustments
Step 3 Extend the balances of all income and expense amounts except the Income Tax Expense.
Step 4 Compute income tax based on income before tax.
Step 5 Total the columns in the Adjustments section.
Step 6 Total the Debit and Credit columns of the Income Statement section before the adjustment for income tax.
Step 7 Extend the adjusted balances of the asset, liability, and stockholder equity accounts to the Balance Sheet columns
STEP 6 we can see on this slide. The total of the Income statement columns before the adjustment for income tax is a debit balance of $1,971,410 and a credit balance of $2,108,000. The difference is net income before tax of $136,590.
Net income before tax ,590

13. Corporate Worksheet Income Tax Adjustment
Compute the income tax expense:
First $ 50,000 x 15 % $ 7,500
Next $ 25,000 x 25 % ,250
Next $ 25,000 x 34 % ,500
Last $ 36,590 x 39 % (rounded) 14,270
Applying the federal income tax rates to the taxable income we can calculate federal taxes of $36,520.
Tax on $136, $36,520

14. Corporate Worksheet Income Tax Adjustment
Compute the income tax adjustment:
Tax deposit April $ 8,994
Tax deposit June ,994
Tax deposit September ,994
Tax deposit December ,994
The business has already made four income tax deposits of $8,994 each for a total of $35,976. Since the total actual tax expense is $36,520, the difference of $544 is the amount of the tax adjustment which is needed on December 31.
Total tax deposits $35,976
Total tax expense 36,520
Tax adjustment –additional tax due $

15. Corporate Worksheet Income Tax Adjustment
Record the income tax adjustment in the Adjustments section of the worksheet:
Income Tax Expense: $ debit
Income Tax Payable: $ credit
Record the income tax adjustment in the Adjustments section of the worksheet as a debit to Income Tax Expense and a credit to the Income Tax Payable account.

16. Adjusting Journal Entries
Objective 3
Record corporate adjusting and closing entries
Adjusting Journal Entries
Using the adjustments column of the worksheet, journalize all of the adjustments in the general journal.
Once the worksheet is complete, the adjustments made on the worksheet still need to be journalized in the general journal and then posted. Closing entries also need to be made and the worksheet is a huge help in performing this step in the accounting cycle.
Remember the purpose of adjusting entries is to ensure correct account balances at the end of accounting period. The purpose of closing entries is to reduce temporary account balances to zero and prepare for the next fiscal period.)
In this slide, let’s discuss adjusting entries. Using the adjustments column of the worksheet, journalize all of the adjustments in the general journal.

17. Closing Entries 1. Close revenue to Income Summary.
2. Close expenses to Income Summary.
3. Close Income Summary (net income or net loss) to Retained Earnings.
The purpose of closing entries is to reduce temporary account balances to zero and prepare for the next fiscal period. The three closing entries for a corporation are seen here. First close revenue to Income Summary. Then close expenses to Income Summary.
and the final closing entry is to close Income Summary (net income or net loss) to the Retained Earnings account. The Retained Earnings account accumulates the profits and losses of the business.
The Retained Earnings account accumulates the profits and losses of the business.

18. The last closing entry for a corporation transfers the net income after income taxes (or the net loss) from the Income Summary account to Retained Earnings.
GENERAL JOURNAL
POST
DATE DESCRIPTION REF. DEBIT CREDIT
2010
Dec. 31 Income Summary ,070.00
Retained Earnings ,070.00
The last closing entry for the corporation which transfers the net income to the Retained Earnings account can be seen here.

19. Extraordinary, Nonrecurring Items
Objective 4
Prepare an income statement for a corporation
Extraordinary, Nonrecurring Items
Extraordinary, nonrecurring items are gains or losses from items that:
are highly unusual,
are clearly unrelated to routine operations, and
do not frequently occur.
Objective 4 is to prepare an income statement for a corporation. The corporate income statement is very similar to the income statements for sole proprietorships and partnerships There are a few differences in a corporate income statement. For example, the corporation has a deduction for Income taxes that does not appear on the income statement of a sole proprietorship or a partnership. In addition, if a corporation has a gain or loss which results from a transaction that is highly unusual, is clearly unrelated to routine operation, and is not expected to occur again in the future, the gain or loss is shown in a separate section called Extraordinary, Nonrecurring Items.
They are shown on the income statement in a separate section titled “Extraordinary Gains and Losses.”

20. Corporate Earnings and Capital Transactions
Chapter 21
Corporate Earnings and Capital Transactions
Section 2: Accounting
for Retained Earnings
Section Objectives
This section of chapter 21 explains how to record the declaration and payment of cash dividends, stock dividends, stock splits and how to record the appropriation of retained earnings.
Record the declaration and payment of cash dividends.
Record the declaration and issuance of stock dividends.
7. Record stock splits.
8. Record appropriations of retained earnings.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

21. Retained Earnings
Does not represent a cash fund.
Are reinvested in:
Inventory
Plant and Equipment
Various other types of assets
May be distributed to stockholders.
Appear in the Stockholders’ Equity section of the balance sheet.
There are two components to stockholder’s equity: Paid In Capital and Retained Earnings.
Paid-in capital is the amount of capital acquired from capital stock transactions.
We can think of Retained Earnings as a reserve account that balances the accounting equation.
This reserve account is not a cash fund. Like a partnership, a corporation has multiple owners and therefore, multiple equity accounts. It would appear in the Stockholders’ Equity section of the balance sheet.

22. Dates Relevant to Dividends
Objective 5
Record the declaration and payment of cash dividends
Dates Relevant to Dividends
Declaration
Date
The date on which the board of directors declares a dividend.
Record
Date
On this date, it is determined which specific stockholders are to receive a dividend.
Corporations distribute a share of the company’s profits to the owners (stockholders) in the form of a dividend. The amount of the dividend and how often dividends are given to shareholders, depends on the company’s dividend policy.
Keep in mind that before a dividend can be declared, the board of directors must consider two issues:
1. Legality
2. Financial Feasibility.
There are three important dividend dates (declaration, record and payment)
Payment
Date
The date on which dividends are paid.

23. To Record Cash Dividends
Declaration Date:
Debit: Retained Earnings
Credit: Dividends Payable (Common or Preferred)
Record Date: A list is made of the stockholders and the number of shares owned by each.
Payment Date:
Debit: Dividends Payable (Common or Preferred)
Credit: Cash
On this slide, we can see the journal entries required on the three important dividend dates. The liability to pay the dividend occurs on the date of DECLARATION. Notice that on the date of RECORD, no actual journal entry is made. The record date is important for determining who is entitled to the dividend but no formal journal entry is required. On the date of PAYMENT the actual checks are written to the stockholders.

24. Stock Dividend Record the declaration and issuance of stock dividends
Objective 6
Record the declaration and issuance of stock dividends
Stock Dividend
A stock dividend is a distribution of corporation’s own stock.
Made on a pro-rata basis.
Results in a conversion of a portion of retained earnings to permanent capital.
Involves the Common Stock Dividends Distributable account.
Sometimes a corporation gives a stock dividend instead of a cash dividend. A stock dividend is a distribution of additional shares of stock to stockholders without additional investment on their part.
A stock dividend transfers from the Retained Earnings section of Stockholder’s Equity up to the Paid-in Capital section the Fair Market Value of the stock to be distributed. Stock dividends involve a new temporary stockholder equity account called Common Stock Dividends Distributable.

25. Common Stock Dividend Distributable Account
The common stock dividend distributable account is an equity account.
Used to record par or stated value of shares to be issued as a result of a stock dividend declaration.
The Common Stock Dividend Distributable account is an equity account which is used to record par or stated value of shares to be issued as a result of a stock dividend declaration. Any excess of market value over par value is credited to the Paid-in Capital in Excess of Par account.
The excess of market value over par value is credited to Paid-in Capital in Excess of Par.

26. To Record Stock Dividends
Declaration
Debit: Retained Earnings
Credit: Common Stock Dividend Distributable
Credit: Paid-in Capital in Excess of Par—Common
Distribution
Debit: Common Stock Dividend Distributable
Credit: Common Stock
The journal entries for a stock dividend can be seen on this slide. Notice the differences in recording a cash dividend and a stock dividend. (Dr. Retained Earnings on the declaration date for both; credit Dividends Payable for the cash dividend and Common Stock Dividend Distributable for the stock dividend)
In addition, unlike the declaration of a cash dividend, no liability is created upon declaration of a stock dividend.

27. Book Value
Represents the total equity applicable to the class of stock divided by the number of shares outstanding.
Remains the same before and after a stock dividend, but each shareholder owns more shares of stock with proportionately lower book value per share.
Book Value represents the total equity applicable to the class of stock divided by the number of shares outstanding. It remains the same before and after a stock dividend, but each shareholder owns more shares of stock with proportionately lower book value per share.
For each class of stock,
book value per share = equity ÷ shares outstanding

28. Stock Split Record stock splits Objective 7
Occurs when a corporation issues two or more shares of new stock to replace each share outstanding without making changes to the capital accounts.
Declared when stock is difficult to sell because of high market price.
Does not change the capital account balances.
Requires only a memorandum notation in the general journal.
Stock splits are often declared when the stock of a company is relatively difficult to sell because the market price is too high. In a stock split, the total number of shares issued increases; however, the total amount invested remains the same. (Each share’s par value, or stated value, decreases.) When a stock split occurs:
A memorandum notation is made in the general journal regarding the split.
An entry is made in the Common Stock account in the general ledger to indicate that par, or stated value, has also changed and the number of shares outstanding is updated as well.
Stockholder records would be updated to reflect the number of shares now held by stockholders.

29. Only a memorandum entry is needed in the general journal.
Stock Split
Only a memorandum entry is needed in the general journal.
2010
Dec. 1 On this date the board of
directors declared a 3-for-1
stock split and reduced the
stated value of common stock
from $75 to $25 per share.
Total outstanding shares will
be 120,000.
This is the required memorandum entry in the general journal to “record” the 3-for-1 stock split. Notice that in the memorandum entry the stated value of the stock went from $75 a share to $25 per share.

30. Record appropriations of retained earnings
Objective 8
Record appropriations of retained earnings
QUESTION:
What is an appropriation of retained
earnings?
An appropriation of retained earnings is a formal declaration of an intention to restrict dividends.
ANSWER:
A corporation’s Retained Earnings account serves the same purpose as a savings account; funds held in this account are often appropriated for specific purposes such as expansion or debt repayment.
An appropriation of retained earnings is a formal declaration of an intention to restrict dividends. This is because dividends cannot be declared out of appropriated retained earnings. The balance sheet must show appropriated and un-appropriated retained earnings separately in two different accounts.
Corporations restrict dividend payments in order to reinvest in plant assets or working capital.

31. It does not mean that cash has been set aside in a fund.
An appropriation of retained earnings reduces the amount of retained earnings available for dividend declarations.
It does not mean that cash has been set aside in a fund.
2010
Oct. 5 Retained Earnings ,000.00
Retained Earnings Appropriated for Retail Center Construction ,000.00
Appropriation for construction made by board of directors on
October 5.
Here is the required journal entry to appropriate retained earnings for future construction of a retail center. The appropriation will reduce the amount of retained earnings which is available for dividend declaration however, it does not mean that cash has been set aside in a fund.
Notice that no entry is made to the Cash account.

32. Corporate Earnings and Capital Transactions
Chapter 21
Corporate Earnings and Capital Transactions
Section 3: Other Capital
Transactions and Financial Statements
Section Objectives
This section of chapter 21 discusses how to record the receipt of donated assets and the journal entries required to record treasury stock transactions. The final objective of the chapter is to prepare the financial statements of a corporation.
9. Record a corporation’s receipt of donated assets.
Record treasury stock transactions.
11. Prepare financial statements for a corporation.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

33. Donated capital is recorded at its fair market value.
Objective 9
Record a corporation’s receipt of donated assets
QUESTION:
What is donated capital?
Donated capital is capital resulting from the receipt of gifts by a corporation.
ANSWER:
How does a company record the receipt of donated assets?
Corporations that receive something of value (cash, land, etc.) through a donation (gift) do not have to give up any equity. The fair market value of the asset is offset by a paid-in capital account called Donated Capital.
Donated capital is recorded at its fair market value.

34. A community that wishes to attract new industry may give a corporation a plant site or building as an inducement for the corporation to move to the community.
2010
Jan. 2 Land ,000.00
Donated Capital ,000.00
Appraised value of plant
site donated by city.
Here is the journal entry to record the receipt of a piece of land. The fair market value of the land is used and is credited to the Donated Capital, stockholder equity account.

35. Treasury Stock Record treasury stock transactions
Objective 10
Record treasury stock transactions
Treasury Stock
Why do corporations purchase their own stock?
The corporation has extra cash.
The corporation offers treasury stock as incentive plans for officers.
The corporation wants to create a demand for the stock, thus increasing its market value.
The corporation can purchase shares of stockholders who need cash or want to retire (privately held corporations).
Sometimes a corporation repurchases its stock. . .
Although treasury stock was once sold and issued, it is stock that has been purchased back by the corporation.
Treasury stock provides no rights, and the shares are not considered outstanding shares.
There are several reasons why a company would purchase their own stock back from shareholders as mentioned above.

36. Record the Purchase of Treasury Stock
2010
Jan. 10 Treasury Stock - Preferred ,200.00
Cash ,200.00
Purchased 400 shares of
treasury stock.
In this journal entry, the company paid $21,200 for 400 shares of its own preferred stock. It debits the Treasury Stock-Preferred and credits Cash for the cost.

37. Financial Statements for a Corporation
Objective 11
Prepare financial statements for a corporation
Financial Statements for a Corporation
Four financial statements are prepared for a corporation:
Income statement
Statement of retained earnings
Balance sheet
Statement of cash flows
In general, the financial statements for a corporation are similar to the financial statements of a sole proprietorship:
The four financial statements which are prepared for a corporation include:
Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows

38. What is a statement of retained earnings?
QUESTION:
What is a statement of retained earnings?
A statement of retained earnings is
a financial statement that shows all changes that have occurred in retained earnings during the period.
ANSWER:
A statement of retained earnings is a financial statement that shows all changes that have occurred in retained earnings during the period. Changes in both appropriated and un-appropriated retained earnings must also be shown.

39. The Corporate Balance Sheet
The Balance Sheet’s asset and liability sections are very similar to a sole proprietorship’s.
Assets
The Balance Sheet’s asset and liability sections are very similar to a sole proprietorship’s except for the Stockholder’s Equity section as opposed to the Owner’s Equity section in a sole proprietorship.
Liabilities

40. College Accounting, 12th Edition
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College Accounting, 12th Edition
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