Corporations: Effects on Retained Earnings and the Income Statement

1. Corporations: Effects on Retained Earnings and the Income Statement Chapter 13

2. Stock Dividend • A distribution of a corporation’s own stock • Affects only stockholders’ equity accounts • No effect on total stockholders’ equity • No effect on assets or liabilities • Stockholders receive proportionate shares • Example–10% stock dividend; every stockholder receives 10% of shares distributed • Total number of shares issued and outstanding increases • Ownership percentages remain the same

3. Why Do Companies Issue Stock Dividends? • Conserve cash • Continue dividends without using cash • Reduce market price per share • Share supply increases; market price decreases • Less expensive; more attractive investment • Reward investors • Shareholders receive something of value

4. Entries for Stock Dividend • Same three dates for a stock dividend • Declaration date; record date; distribution date • Small stock dividend • Distribution is less than 20 to 25% of issued shares • Debit(Reduce) Retained earnings for market value of shares to be distributed • Credit (Increase)Common stock for the par value of the stock and • Credit (Increase)Paid-in capital (if applicable) for excess of par—common • Total Stockholders Equity does not change

5. Equity after 5% Common Stock Dividend

6. Entries for Stock Dividend (Continued) • Large • Distribution is greater than 20% to 25% of issued shares • Debit (Reduce) Retained earnings for par or stated value of shares • Credit (Increase) Common stock for par or stated value of shares • Rare • Total Stockholders Equity does not change • Assume a second stock dividend of 50% • An additional 1,050,000 shares will be issued (2,100,000 x 50%) • Total shares issued will be 3,1050,000 shares (2,100,000 + 1,050,000)

7. Stockholders’ Equity Presentation • Equity after 50% Common Stock Dividend

8. S13-2: Comparing and contrasting cash and stock dividends Compare and contrast the accounting for cash dividends and stock dividends. • In the space provided, insert either “Cash dividends,” “Stock dividends,” or “Both cash dividends and stock dividends” to complete each of the following statements: a. ________________decrease Retained earnings. b. ________________ has(have) no effect on a liability. Both cash dividends and stock dividends Stock dividends

9. S13-2: Comparing and contrasting cash and stock dividends (Continued) c. ________________ increase Paid-in capital by the same amount that they decrease Retained earnings. d. ________________ decrease both total assets and total stockholders’ equity, resulting in a decrease in the size of the company. Stock dividends Cash dividends

10. S13-3: Accounting for a stock dividend Yummy, Inc., had 310,000 shares of $1 par common stock issued and outstanding as of December 1, 2012. The company is authorized to issue 1,400,000 common shares. On December 15, 2012, Yummy declared and distributed a 5% stock dividend when the market value for Yummy’s common stock was $3. Requirements: 1. Journalize the stock dividend. 2. How many shares of common stock are outstanding after the dividend?

11. S13-3: Accounting for a stock dividend • Journalize the stock dividend. 2. How many shares of common stock are outstanding after the dividend? 15,500 x $3 310,000 +15,500 (310,000 x 5%)= 325,500

12. Stock Splits • A stock split: • Cuts par value per share • Increases the number of shares of stock issued and outstanding • Leaves all account balances and total stockholders’ equity unchanged • Balances in the accounts are unchanged • Record in a memorandum entry–a journal entry without debits and credits

13. Stock Split Example (2 for 1) • Before split • After split

14. Effects of Dividends and Stock Splits • Stock dividends and stock splits have similarities and differences

15. S13-5: Accounting for a stock split Decorator Plus Imports recently reported the following stockholders’ equity (adapted except par value per share): Suppose Decorator Plus split its common stock 2 for 1 in order to decrease the market price per share of its stock. The company’s stock was trading at $20 per share immediately before the split.

16. S13-5: Accounting for a stock split 1. Prepare the stockholders’ equity section of Decorator Plus Imports’ balance sheet after the stock split.

17. S13-5: Accounting for a stock split 2. Were the account balances changed or unchanged after the stock split? Unchanged Unchanged Unchanged Unchanged

18. Treasury Stock • Shares that a company has issued and later reacquired • Reasons corporations purchase their own stock: • To increase net assets by buying low and selling high • To support the company’s stock price • To avoid a takeover by an outside party • To reward valued employees with stock • A common practice among corporations

19. Accounting for Treasury Stock • Contra equity account • Debit balance • Recorded at cost (not par) • Reported beneath Retained earnings on the balance sheet • Reduction to total stockholders’ equity • Decreases outstanding shares • Not eligible for dividends • Not eligible to vote Issued stock – Treasury stock = Outstanding stock

20. Treasury Stock transactions

21. Treasury Stock Journal Entries • Purchase of treasury stock • Company debits Treasury stock and credits Cash

22. Treasury Stock Journal Entries • Sale of treasury stock at cost

23. Treasury Stock Journal Entries • Sale of treasury stock above cost • Difference is credited to Paid-in capital from treasury stock transactions

24. Treasury Stock Journal Entries

25. Treasury Stock Journal Entries • Sale of treasury stock below cost • Difference is debited to Paid-in Capital from treasury stock transactions, if available • Otherwise debit Retained earnings

26. Treasury Stock Journal Entries

27. Treasury Stock Journal Entries • Sale of treasury stock below cost • Paid-in capital from treasury stock transactions is insufficient to cover shortfall • Debit Retained earnings for the difference

28. Treasury Stock Journal Entries

29. Treasury Stock and Stockholders' Equity • Reported beneath Retained earnings as a reduction Authorized shares - 20,000,000 Issued shares - 6,300,000 Outstanding shares - 6,299,700

30. Treasury Stock

31. S13-6: Accounting for the purchase and sale of treasury stock Discount Center Furniture, Inc., completed the following treasury stock transactions: • Purchased 1,400 shares of the company’s $1 par common stock as treasury stock, paying cash of $5 per share. • Sold 400 shares of the treasury stock for cash of $8 per share. Requirements • Journalize these transactions. Explanations are not required. • Show how Discount Center will report treasury stock on its December 31, 2012 balance sheet after completing the two transactions. In reporting the treasury stock, report only on the Treasury stock account.

32. S13-6: Accounting for the purchase and sale of treasury stock • Journalize these transactions. Explanations are not required.

33. S13-6: Accounting for the purchase and sale of treasury stock 2. Show how Discount Center will report treasury stock on its December 31, 2012 balance sheet after completing the two transactions. In reporting the treasury stock, report only on the Treasury stock account.

34. Restrictions on Retained Earnings • Restrictions • Requirement by lenders to maintain a minimum level of equity by limiting: • Cash dividend payments • Treasury stock purchases • Reported in the notes to the financial statements • Appropriations • Restrictions on retained earnings recorded by formal journal entries • Board of directors may designate purpose of appropriation • Segregate in a separate account • Aportion of retained earnings for a specific use

35. Stockholders’ Equity with Appropriations • The heading Paid-in capital does not appear • All additional paid-in capital accounts are combined

36. The Corporate Income Statement • More complex with unique items • Public corporations must publish financial statements • Sections • Continuing Operations • Special Items • Earnings Per Share • Details important to investors

37. The Corporate Income Statement • Continuing Operations • Unique items • Gain on sales of machinery–other • Not core to the business • Income tax expense • Subtracted to arrive at income from continuing operations Should continue from period to period Useful for making projections about future earnings

38. Special Items • Reported after income from continuing operations • Two distinctly different gains and losses: • Discontinued operations • Extraordinary items

39. Discontinued Operations • Segment of a business that has been sold • Each segment is an identifiable division of company • Reported separately because the segment will not be around in the future • Shown net of tax • Gain - income tax expense = Gain, net of tax • Loss - income tax savings = Loss, net of tax

40. Extraordinary Items • Extraordinary gains and losses • Both unusual and infrequent • Not expected to recur in the foreseeable future • Examples: • Losses from natural disasters • Foreign government takeover (expropriation) • Reported net of income tax effect • Items notqualifying as extraordinary • Gains and losses on the sale of plant assets • Losses due to lawsuits • Losses due to employee labor strikes • Natural disasters that occur frequently in the area

41. Earnings per Share (EPS) • Most widely used business statistic • Measures amount of net income for each share of common stock outstanding • Issued stock – treasury stock = outstanding shares • Key measure of success in business • Separate EPS figure for each element of income • Income from continuing operations • Income from discontinued operations • Income before extraordinary item • Extraordinary gain or loss • Net income

42. Earnings per Share (EPS) • Calculation • Preferred dividends also affect EPS

43. EPS and Preferred Stock • Preferred dividends must be subtracted from income to compute EPS • Preferred dividends are paid first • Common will get what is left * Assume the annual preferred dividend would be $10,000 (10,000 shares X $1.00 dividend per share)

44. E13-20: Computing EPS Altar, Corp., earned net income of $118,000 for 2012. Altar’s books include the following figures: Preferred stock, 3%, $50 par, 1,000 shares issued and outstanding . . . . . . . . . . . . . . . . . . . . . $ 50,000 Common stock, $2 par, 53,000 issued . . . . . . . . . .106,000 Paid-in capital in excess of par—common . . . . . .460,000 Treasury stock, common, 1,200 at cost . . . . . . . . .. 24,000 • Compute Altar’s EPS for the year. $(118,000 – 15,000)/51,800 = $2.25* (2.249034749034749) rounded

45. Statement of Retained Earnings • Reports how retained earnings changed over the accounting period • Corporate dividends appear where drawings would appear in proprietorships or partnerships

46. Prior-Period Adjustments • Corrections for errors of an earlier period • Due to the closing of accounts, the error is held in Retained earnings • Correction called prior-period adjustment • 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