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Corporations: Retained Earnings and the Income Statement

Corporations: Retained Earnings and the Income Statement. Chapter 12. Retained Earnings. All net income minus net losses minus dividends Negative balance in Retained Earnings - deficit Not a fund of cash. Objective 1. Account for stock dividends. Stock Dividend.

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Corporations: Retained Earnings and the Income Statement

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  1. Corporations:Retained Earnings and the Income Statement Chapter 12

  2. Retained Earnings • All net income minus net losses minus dividends • Negative balance in Retained Earnings - deficit • Not a fund of cash

  3. Objective 1 Account for stock dividends

  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

  5. Small Distribution is < 20-25% 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 Entries for Stock Dividend

  6. E12-13 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

  7. E12-13 Apr 30 Retained Earnings 70,000 Common Stock 5,000 Paid in Capital in Excess of Par, Common 65,000 USE PAR Common stock = 5,000 shares x $1 USE MARKET VALUE 5,000 shares x $14

  8. E12-13 The number of shares issued increased. Retained earnings decreased 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 par 265,000 Total paid in capital $320,000 Retained earnings ($120,000-70,000) 50,000 Total stockholders’ equity $370,000 Total stockholders’ equity is the same

  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

  10. E12-15 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.

  11. E12-3 Shares authorized and issued are double Par value is cut in half 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 par 100,000 Total paid in capital $150,000 Retained earnings 200,000 Total stockholders’ equity $350,000 None of the amounts in the accounts have changed

  12. Objective 2 Distinguish stock splits from stock dividends

  13. 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 Comparison: StockDividends & Stock Splits

  14. Objective 3 Account for treasury stock

  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

  16. Contra Equity Account E12-17 Feb 4 Cash 200,000 Common Stock 20,000 Paid in Capital in Excess of Par, Common 180,000 Apr 22 Treasury Stock 14,000 Cash 14,000

  17. E12-17 Aug 22 Cash 12,000 Treasury Stock 8,400 Paid in Capital from Treasury Stock Transactions 3,600

  18. E12-17 Paid in Capital In Excess of Par, Common Paid in Capitalfrom Treasury Stock Transactions Common Stock 20,000 180,000 3,600 Retained Earnings Treasury Stock 100,000* 14,000 8,400 5,600 *Assumed

  19. 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, Common 180,000 Paid in Capital from Treasury Stock Transactions 3,600 Total Paid in Capital $203,600 Retained Earnings 100,000 Subtotal $303,600 Less Treasury Stock (400 shares at cost) 5,600 Total Stockholders’ Equity $298,000 *Assumed

  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)

  21. Retirement of Stock • Decreases outstanding stock • Retired shares cannot be reissued • Remove stock from books • Debit stock accounts • Credit cash

  22. Objective 4 Report restrictions on retained earnings

  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

  24. E12-19 a 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.

  25. E12-19 b

  26. Objective 5 Analyze a corporate income statement

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

  28. Income from Continuing Operations • Measures profitability of the ongoing operations • Useful for making projections about future earnings

  29. Special Items • Reported after income from continuing operations • Discontinued operations • Extraordinary gains and losses

  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

  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

  32. E12-20 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 savings 20,000(30,000) Income before extraordinary items $40,000 Extraordinary loss $(15,000) Income tax savings 6,000 (9,000) Net income $31,000

  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

  34. Earnings Per Shareand Preferred Stock Corporations with complex capital structures present two sets of EPS amounts • Basic EPS • Diluted EPS

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

  36. E12-22 Preferred dividends:10,000  $10  .05 = $5,000 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

  37. Statement of Retained Earnings • Reports how retained earnings changed over the accounting period • Beginning balance + net income – dividends = Ending balance

  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

  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

  40. E12-24 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 adjusted 34,000 Net income for 2003 70,000 Subtotal 104,000 Dividends for 2003 (24,000) Retained earnings, December 31, 2003 $80,000

  41. End of Chapter 12

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