Unit 8 Accounting for Changes in Shareholders’ Equity

Corporate Capital Owner's equity in a corporation is identified as stockholders' equity, shareholders' equity, or corporate capital. The stockholders' equity section of a corporation's balance sheet consists of: (a) paid-in (contributed) capital, and (b) retained earnings (earned capital). Paid in or contri!uted capital is the in est!ent of cash and other assets in the corporation by stockholders in e"change for capital stock. "etained earnings account is net inco!e retained in a corporation and is part of the stockholders# clai! on the total assets of the corporation. The entire a!ount of retained earnings !ay be presu!ed to be unrestricted as to di idend declaration unless restrictions are indicated in the financial state!ents. a. $et inco!e is recorded in %etained &arnings by a closing entry with a debit to 'nco!e (u!!ary and a credit to %etained &arnings. Pro-forma entry: 'nco!e (u!!ary %etained &arnings To close net inco!e for the period. """ """

b. ) net loss is debited to %etained &arnings in a closing entry. Pro-forma entry: %etained &arnings 'nco!e (u!!ary To close net loss for the period. """ """

c. The retained earnings (earned capital) account is part of the stockholders' equity section of a corporation. d. ) debit balance in %etained &arnings is identified as a deficit and is reported as a deduction in the stockholders# equity section.

"etained Earnings "estrictions *. %etained earnings restrictions !ake a portion of the retained earnings balance currently una ailable for di idends.

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%estrictions result fro! one or !ore of the following causes: a. ,egal restrictions. -any states require a corporation to restrict retained earnings for the cost of treasury stock purchased. Pro-forma entry: %etained &arnings %etained earnings appropriated for cost of treasury stocks To record appropriation for cost of treasury shares. b. """ """

.ontractual restrictions or any future contingencies. ,ong-ter! debt contracts !ay restrict retained earnings as a condition for a loan. Pro-forma entry: %etained &arnings %etained earnings appropriated for contingencies To record appropriation for future contingencies. """ """

c.

/oluntary restrictions. The board of directors !ay oluntarily create retained earnings restrictions for specific purposes (for e"a!ple, future plant e"pansion). Pro-forma entry: %etained &arnings %etained earnings appropriated for plant e"pansion To record appropriation for future plant e"pansion. """ """

0.

%etained earnings restrictions are generally disclosed in the notes to the financial state!ents. The retained earnings account has a nor!al credit balance. ) debit balance in the retained earnings account is called a deficit.

1. 2hen the cause for restriction no longer e"ists, the appropriation is not necessary any!ore. ) re ersing entry is prepared restoring the a!ount of appropriation back to the unrestricted balance. Pro-forma entry: %etained earnings appropriated for plant e"pansion """ %etained &arnings To record re ersal of the appropriation for future plant e"pansion.

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In Summary: "etained Earnings Credit $et inco!e %e ersal of appropriations

Debit $et loss

)ppropriations for treasury shares, contingencies, plant e"pansion, etc. ,osses fro! sale of treasury stock 3eclaration of di idends

ACCOUNTING FO T !ASU " S#A !S
Trea$ury $toc%&$'are$ is an entity#s own stock that has been issued and then reacquired but not canceled. The corporation !ay reissue these treasury shares at so!e future date. 4ro! this definition, three requisites !ust be present in order that a stock should qualify as treasury stock. *. The stock !ust be the entity#s own stock. +. The stock !ust ha e been issued originally. 0. The stock is reacquired but not canceled. (/ali" and 5eralta, +667)

ea$on$ for Ac(uirin) Trea$ury Stoc%
*. +. 0. 1. 8. 7. To obtain stock to be used in the acquisition of plant assets. To i!pro e earnings per share by reducing the nu!ber of shares outstanding. To in est e"cess cash te!porarily. To support the !arket price of the stock. To increase the ratio of liabilities to stockholders# equity. To obtain shares for con ersion of other securities such as preferred stock. (9aysa and ,upisan, +66:)

T*o Accountin) +et'od$ to ecord Trea$ury Stoc%
*. .ost !ethod ; This is the !ethod to be used under local accounting standards +. 5ar alue !ethod

T*o ,ind$ of Trea$ury Stoc%
*. eac(ui$ition by purc'a$e ; under the cost !ethod a. Treasury stocks are recorded at cost. Pro-forma entry: Treasury (tock .ash %e-acquired own stocks at 5<< per share.

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b. 2hen treasury stocks are reissued or sold at !ore than cost, the indicated gain is credited to an account called =(hare pre!iu! - treasury shares>. Pro-forma entry: .ash """ Treasury (tock """ (hare pre!iu! - treasury shares """ %e-issued treasury stocks at abo e cost.

c. 2hen treasury stocks are reissued or sold below cost, the indicated loss is debited to *) S'are premium - trea$ury $'are$ if there is an e"isting balance for this account until all the a!ount has been e"hausted and +) etained !arnin)$ if the entire a!ount in the (hare pre!iu! - treasury shares account has been fully e"hausted. Pro-forma entry: .ash """ (hare pre!iu! - treasury shares """ Treasury (tock """ %e-issued treasury stocks below cost. Or Pro-forma entry: .ash (hare pre!iu! - treasury shares %etained &arnings Treasury (tock %e-issued treasury stocks below cost. Or Pro-forma entry: .ash %etained &arnings Treasury (tock %e-issued treasury stocks below cost. """ """ """ """ """ """ """

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eac(ui$ition by donation ; 3onated stock refers to shares of stock recei ed by the entity fro! its stockholders by way of donation. These stocks are actually treasury stock and !ay therefore be reissued at any price without any discount liability. 3onated stock is secured without cost and consequently, it does not affect the entity#s assets, liabilities and stockholders# equity, although it reduces outstanding shares. ?owe er, the reissue or resale of donated stock increases assets and additional paid in capital. .ontributions, including stock of the corporation, recei ed fro! shareholders shall be recorded at the fair -alue of t'e item$ recei-ed *it' t'e credit )oin) to .Additional Paid in Capital / Donated Stoc%$> account0 (/ali" and 5eralta, +667) Pro-forma entry for t'e receipt of o*n $'are$ of $toc%$ a$ donation -e!orandu! entry: %ecei ed <<< shares fro! %@- as donation.

Pro-forma entry for t'e $ale of donated $'are$ .ash (hare pre!iu! - donated stocks %e-issuance of stocks recei ed as donation. """ """

Important Note$ *. Treasury shares do not ha e the status of outstanding shares, therefore, these shares are not entitled for di idends. +. Treasury shares do not entitle the holder to the rights of a stockholder. 0. Treasury stock is not iewed as an asset (i.e., 'n est!ents in Trading (ecurities) but as a reduction to total stockholders# equity. 1. To protect creditors, a portion of retained earnings shall be restricted equal to the cost of the treasury stock.

Unit # Accounting for Accu$ulated Profits%&osses
Di-idend$
) di-idend is a distribution by a corporation to its stockholders on a pro rata (proportional) basis. 3i idends !ay be in the for! of cash, property, scrip, or stock. The power to declare di idends is ested upon the board of directors. 3i idends shall be paid out of unrestricted or free retained earnings. The following shares are entitled to recei e di idends: a. all issued and outstanding shares b. all subscribed par alue shares The following shares are not entitles to recei e di idends: a. unissued shares b. subscribed no par shares c. treasury stock

T*o ,ind$ of Di-idend$
*. Di-idend$ out of earnin)$ ; distribution to stockholders of corporate earnings in proportion to the nu!ber of shares held by the!A also known as return on in est!ent. +. Di-idend$ out of capital (liquidating di idends) ; a return of stockholders# in ested capitalA also known as return of in est!ent.

Form$ of di-idend$
) ca$' di-idend is a pro rata distribution of cash to stockholders. 4or a corporation to pay a cash di idend, it !ust ha e (a) retained earnings, (b) adequate cash, and (c) declared di idends. ) $crip di-idend is a deferred cash di idend. This is consisting of a written pro!ise to pay certain a!ounts at so!e future date. ) scrip di idend is declared when the corporation has sufficient retained earnings balance but not sufficient funds at the ti!e for a cash di idend. The pay!ent nor!ally includes the principal a!ount and an interest at a specified rate. ) property di-idend is a di idend distributable in the for! of non cash assets. This type of di idend reduces retained earnings by the cost or carrying alue of the property on the date of declaration. 5roperty distributed nor!ally takes the for! of assets that can be easily di ided or allocated a!ong stockholders, for e"a!ple, the stocks of other corporation owned by the co!pany (,upisan and 9aysa, +66:). ) $toc% di-idend is a distribution of di idends in the for! of corporation#s own stock.

T'ree date$ are important in connection *it' di-idend$:
a. b. 'eclaration datethe date on which the board of directors for!ally declares a cash di idend and the liability is recorded. "ecord datethe date that !arks the ti!e when ownership of outstanding shares is deter!ined fro! the stockholders' records !aintained by the corporation. Pay$ent datethe date di idend checks are !ailed to the stockholders and the pay!ent of the di idend is recorded.

c.

Preference stockholders !ust be paid di idends before co!!on stockholders recei e di idends. a. 2hen preferred stock is cu$ulati(e, any di idends in arrears !ust be paid to preferred stockholders before allocating any di idends to co!!on stockholders. 2hen preferred stock is not cu!ulati e, only the current year's di idend !ust be paid to preferred stockholders before paying any di idends to co!!on stockholders.

b.

Stoc% Di-idend
*. ) stock di idend is a pro rata distribution to stockholders of the corporation#s own stock. The corporation declares stock di idends when it wishes to declare di idends but at the sa!e ti!e retain the net assets of the business. 4or a corporation to declare stock di idends there should be unrestricted retained earnings and a ailable original and unissued shares which !ay be issued as stock di idends ) stock di idend results in a decrease in retained earnings and an increase in paidin capital. Bnlike a cash di idend, a stock di idend does not decrease total stockholders# equity or total assets. 't only in ol es transfer of a!ount fro! retained earnings to contributed capital. 4or s!all stock di idends (less than +6C) the accounting profession reco!!ends that the board of directors assign the fair !arket alue per share. 5ar or stated alue per share is nor!ally assigned for large stock di idends (greater than +6C). (tock di idends ha e no effect on the par or stated alue per share, but the nu!ber of shares outstanding increases, and the book alue per share decreases.

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T*o ,ind$ of Stoc% Di-idend$
*. Small $toc% di-idend$ ; a stock di idend representing less than +6C of the outstanding shares. The account %etained earnings is debited for the fair mar%et -alue of the stock on the date of declaration. 2hen the fair !arket alue of the stock is used, the following entry is !ade at the declaration date: Date of Declaration: Pro-forma !ntry %etained &arnings.........................................................................""" (tock 3i idends 3istributable................................................... (hare pre!iu! ; (tock di idend............................................ """ """

Stoc% Di-idend$ Di$tributable is reported in paid-in capital as an addition to either co!!on or preferred stock issued. This account is credited for the par or stated alue of the shares to be distributed regardless of whether the stock di idend is s!all or large. This account is not a current liability because it will not be settled through the use of current assets and is shown as an addition to capital stock outstanding. S'are premium-Stoc% di-idend account is credited for the e"cess of the fair !arket alue o er its par or stated alue. Date of Di$tribution: Pro-forma entry (tock 3i idends 3istributable DDDD.DDDDD...D """ Ordinary or 5reference share DDDDDDDDDDDDD.. """

+. 1ar)e $toc% di-idend$ ; a stock di idend representing +6C or !ore of the outstanding shares. The account %etained earnings is debited for t'e par or $tated -alue of the stock. Date of Declaration: Pro-forma !ntry %etained &arnings.........................................................................""" (tock 3i idends 3istributable................................................... Date of Di$tribution: Pro-forma entry (tock 3i idends 3istributable DDDDDDDDDDD.D """ """ Ordinary or 5reference share DD DDDDDDDDDDD.. """

(tock di idends change the co!position of stockholders' equity because a portion of retained earnings is transferred to paid-in capital. ?owe er, total stockholders' equity and the par or stated alue per share re!ains the sa!e.

Ca$' Di-idend$
*. +. ) cash di idend is a pro rata distribution of cash to stockholders. 4or a corporation to pay a cash di idend, it !ust ha e: a. %etained earnings. b. )dequate cash. c. ) declaration of di idends. 0. Three dates are i!portant in connection with di idends: a. The declaration date: the date the board of directors for!ally declares (authoriEes) the cash di idend and announces it to stockholders. )n entry is required to recogniEe the decrease in retained earnings, and the increase in the liability di idends payable. Date of Declaration: Pro-forma !ntry %etained &arnings......................................................""" 3i idends 5ayableD............................................... b. """

The record date: the date when ownership of the outstanding shares is deter!ined for di idend purposes. The records !aintained by the corporation supply this infor!ation. Date of ecord: No !ntry

c.

The pay!ent date: the date the di idend checks are !ailed to the stockholders and the pay!ent of the di idend is recorded. Date of Payment: Pro-forma entry 3i idends 5ayableD................................................""" .ashDDDDDDDDDDDDDDDDDD.DDD.."""

1.

5referred stock has priority o er co!!on stock in regard to di idends. 5referred stockholders !ust be paid any unpaid prior-year di idends before co!!on stockholders recei e di idends if the preferred stock is cu!ulati e.

S'are'older$2 !(uity Statement
'nstead of presenting a detailed stockholders' equity section in the balance sheet and a retained earnings state!ent, !any co!panies prepare a shareholders' equity state$ent.

Corporation Income Statement
*. 'nco!e state!ents for corporations are the sa!e as the state!ents for proprietorships or partnerships e"cept for the reporting of inco!e ta"es. 'nco!e ta" e"pense is reported in a separate section of the corporation inco!e state!ent before net inco!e. ) corporation is considered a separate legal entity for inco!e ta" purposes. 'nco!e ta" e"pense and the related liability for inco!e ta"es payable are recorded as part of the adFusting process.

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