LECTURE NOTES—Accounting for Corporations: Stockholders’ Equity

Introduction—Chapter Study Objectives:

1. Identify the major characteristics of a corporation.
2. Differentiate between paid-in capital and retained earnings.
3. Record the issuance of common stock.
4. Explain the accounting for treasury stock.
5. Differentiate preferred stock from common stock.
6. Prepare a stockholders’ equity section.
7. Compute book value per share.
8. Prepare the entries for cash dividends and stock dividends.
9. Identify the items that are reported in a retained earnings statement.
10. Prepare and analyze a comprehensive stockholders’ equity section.
11. Describe the form and content of corporation income statements.
12. Compute earnings per share

I. The Corporate Form of Organization: the equity section for corporations

have 2 sections in Stockholders’ Equity s: (1) Capital Stock showing the amount and
types of capital stock that has been issued and (2) Retained Earnings which
represents the net income retained in the corporation and not paid out to
stockholders in the form of dividends. The account “Dividends” that are amount
paid out to stockholders has a normal debit balance and “Owners’ Equity” or
Stockholders’ Equity made up of Capital Stock and Retained Earnings have normal
credit balances.
A. A corporation is an entity created by law that is separate and distinct from its
owners.
B. Its continued existence is dependent upon the statutes of the state in which it
is incorporated.
C. Two common bases for classification of corporations are:
1. by purpose
2. by ownership
D. Classifications of Corporations
1. A corporation’s purpose may be to earn a profit, or it may be organized as
nonprofit.
2. Classification by ownership distinguishes between publicly-held
corporations and privately held corporations.
a) Publicly-held corporations may have thousands of
stockholders, and its stock is regularly traded on a national
securities exchange.
b) Privately-held corporations, often referred to as closely held
corporations, usually have only a few stockholders, and does not
offer its stock for sale to the general public.

II. Characteristics of a Corporation

A. The corporation has separate legal existence from its owners.

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 B. The stockholders have limited liability.
C. Ownership is held in shares of capital stock, which are transferable units.
D. The corporation has the ability to acquire capital through the issuance of
stock.
E. The corporation can have a continuous life.
F. The corporate management is at the discretion of the board of directors
who are elected by the stockholders.
G. The corporation is subject to numerous government regulations.
H. The corporation must pay an income tax on its earnings, and the stockholders
are required to pay taxes on the dividends they receive: the result is double
taxation.

I. Advantages and disadvantages of a corporation—note how you need

to weigh the advantages and disadvantages:
1. Advantages:
a) Separate legal existence
b) Limited liability of stockholders
c) Transferable ownership rights
d) Ability to acquire capital
e) Continuous life
f) Corporation management—professional managers
2. Disadvantages:
a) Corporations management—separation of ownership and
management
b) Government regulations
c) Additional taxes

III. Forming a Corporation

A. Initial Steps:
1. Filing an application with the Secretary of State in the state in which
incorporation is desired
2. Receiving a charter (articles of incorporation) which creates the
corporation
3. Developing by-laws, which establish the internal rules and procedures
for conducting the affairs of the corporation and indicate the powers of
parties involved.
B. Organization Costs
1. Costs incurred in forming a corporation are called organization
costs.
2. These costs include legal fees and state fees, and promotional
expenditures.
3. Organization costs are expensed as incurred since it is so difficult
to determine the amount and timing of future benefits.

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IV. Ownership Rights of Stockholders
A. Each share of common stock gives the stockholder the following ownership
rights:
1. Vote in the election of board of directors and in actions that require
stockholder approval.
2. Share in corporate earnings through the receipt of dividends.
3. Maintain the same percentage ownership when additional shares of
common stock are issued (preemptive right).
4. Share in assets upon liquidation (residual claim).

V. Stock Issue Considerations Issuance of Stock—STOCK ISSUE TERMS:

A. Authorized Stock:
1. Authorized stock is the amount of stock a corporation is allowed to
sell as indicated by its charter or anticipated number of shares to meet
the needs of the company and included in the corporate charter.
2. The authorization of capital stock does not result in a formal
accounting entry. This event has no immediate effect on either corporate
assets or stockholders’ equity.
B. Issuance of Stock:
1. A corporation can issue common stock directly to investors or
indirectly through an investment banking firm (brokerage house).
a. Direct issue is typical in closely held companies.
b. Indirect issue is customary for a publicly held corporation.
 In an indirect issue, the investment banking firm may agree to
underwrite the entire stock issue.
C. Stock market price information
1. The stock of publicly held companies is traded on organized
exchanges. Dollar prices per share are established by the interaction
between buyers and sellers.
2. The prices set by the marketplace generally follow the trend of a
company’s earnings and dividends.
D. Stock Issue Considerations Par and No-Par Value Stocks
1. Par value stock is capital stock that has been assigned a value per share
in the corporate charter.
 It represents the legal capital per share that must be retained in
the business for the protection of corporate creditors. This is only
a dollar amount (not necessarily the amount of cash in the cash
account) that the creditors have claim to the assets of the
corporation.
2. No-par stock is capital stock that has not been assigned a value in the
corporate charter.
a. In many states the board of directors can assign a stated value to the
shares which then becomes the legal capital per share.

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 b. When there is no assigned stated value, the entire proceeds are
considered to be legal capital.
3. RELATIONSHIP OF PAR AND NO-PAR VALUE STOCK TO LEGAL
CAPITAL:
Stock Legal Capital per Share
Par value Par value
No-par value with stated value Stated value
No-par value without stated value Entire Proceeds
VI. Corporate Capital
A. Owner’s equity in a corporation is identified as stockholders’ equity, share-
holders’ equity, or corporate capital.
B. The stockholders’ equity section of a corporation’s balance sheet consists of:
1. Paid-in (contributed) capital - the total amount of cash and other assets
paid in to the corporation by stockholders in exchange for capital stock.
2. Retained earnings - net income that is retained in a corporation.
C. Retained Earnings is net income retained in a corporation and is recorded in
Retained Earnings by a closing entry in which Income Summary is debited
and Retained Earnings is credited. Closing Process for a Corporation
where revenues (R) are first closed into Income Summary; expenses (E) are
secondly closed into Income Summary; and the last step would be the closing
of net income or net loss shown in the Income Summary (I) account into
Retained Earnings if there has not been any dividends paid out to
stockholders. If dividends have been paid out to stockholder, then there is the
4th step to close Dividends (D) into Retained Earnings. Below is the example
to close Income Summary that has a NET INCOME (entry would be
reversed for a Net Loss):
General Journal Page 1
Date Account Title P.R Debit Credit
20-- Closing Entries
Dec. 31 Income Summary 130,000
Retained Earnings 130,000

D. Stockholders’ equity section of a balance sheet:

DELTA ROBOTICS
Balance Sheet (Partial)
Date
Stockholders’ equity:
Paid-in-capital::
Common stock $800,000
Retained Earnings 130,000
Total stockholders’ equity $930,000
E. The Accounting Equation for a Corporation defining the two sections
of the Stockholders’ Equity:

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 1. Paid-in Capital—capital that has been contributed by the stockholders
through the purchase of a company’s stock which is the total amount of
cash and other assets paid in to the corporation by stockholders in
exchange for capital stock.
2. Earned Capital—earnings that have been retained or plowed back into
the corporation which comes from the net income of the corporation that
is retained (Retained Earnings) and not paid out to the stockholders in the
form of dividends.
F. Expanded Accounting Equation:
1. Under the Owner’s Equity for a Corporation:
a. Common Stock represents the Paid-in Capital because if a
corporation has only one class of stock, it is identified as common
stock.
b. Retained Earnings showing that under this section which would be
the net income retained in the business are the sections:
1) Revenues and Expenses which would provide the net
income or the net loss of the corporation. Profit or Loss
Distribution for a Corporation showing how net income increases
Retained Earnings and how net loss decreases Retained Earnings.
2) Dividends which is a distribution to the stockholders on a
pro rata (proportional) basis. Therefore after dividends are paid
out to the stockholders (if any is paid out) the remaining amount
of net income is retained in the company which is the balance in
the Retained Earnings account.
G. Compare the FINANCIAL STATEMENTS FOR A SOLE
PROPIETOPRSHIP with those for a CORPORATION:
1. For the sole proprietorship, the owner’s equity is the Owners, Capital
account which represents the net income or net loss of the company less
any drawings paid out to the owner.
2. For the corporation, the stockholders’ equity must disclose:
a) Capital stock which would represent the sources of paid-in
capital (the classes or types of paid-in capital will be covered in the
next sections).
b) Retained earnings
VII. Accounting for Common Stock Issues
A. The primary objectives in accounting for the issuance of common stock are:
3. to identify the specific sources of paid- in capital and
4. to maintain the distinction between paid-in capital and retained
earnings.

B. The issuance of common stock affects only paid-in capital accounts:

ISSUANCE OF STOCK example where Boomer Corporation issues 2,000 shares
of common stock at $10 per share under 4 situations: (1) Stock at $4 par value;
(2) Stock at no par value where the entire proceeds is legal capital; (3) Stock has
$4 stated value; and (4) Stock has no stated value where the entire proceeds is

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 legal capital and Note: The amount credited to the Common Stock
account becomes legal capital for the protection of the corporation’s
creditors:
1. ISSUING PAR VALUE COMMON STOCK FOR CASH where par
value does NOT represent the stock’s market value but is defined as
capital stock that has been assigned value per share in the corporate or
the legal amount assigned to each share of stock in the corporate charter
Since par value does not indicate the stock’s market value, the cash
proceeds from issuing par value stock may be equal to, greater than, or
less than par value as follows:
a) Illustration of issuing common stock at par for cash:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Cash 1,000
Common Stock 1,000
(record issuance of 1000 shs.@ $1 par)

b) Illustration of issuing common stock above par for cash

where an account called, “Paid-in Capital in Excess of Par Value” will
show the amount above legal capital where the “Common Stock”
account will only show the legal capital (creditors claim) or par value:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Cash 5,000
Common Stock 1,000
Paid-in Capital in Excess of Par Value 4,000
(record issuance of 1000 shs.@ $5/sh.)
The total paid-in capital of the above two transactions is $6,000, and the legal capital
is $2,000.
c) Issuing common stock below par for cash would result is
debit to Paid-in Capital in Excess of Par Value and a credit to cash.
But this situation rarely occurs as the sale of common stock below
par value is not permitted in most states, because stockholders may be
held personally liable for the difference between the price paid upon
original sale and par value.
d). Stockholders’ equity -paid-in-capital in excess of par value :
HYDRO-SLIDE, INC.
Balance Sheet (Partial)
Date
Stockholders’ equity:
Paid-in-capital::
Common stock $2,000
Paid-in capital in excess of par value 4,000

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 Total paid-in capital 6,000
Retained Earnings 27,000
Total stockholders’ equity $33,000

2. ISSUING NO-PAR COMMON STOCK FOR CASH

a) When no par stock has a stated value as in the following
example with $5 stated value and note the word “stated” must be used
in the account showing the excess above the legal capital in place of
the word, “par”:

General Journal Page 1

Date Account Title P.R Debit Credit
20--
Mo. Day Cash 40,000
Common Stock 25,000
Paid-in Capital in Excess of Stated Value 15,000
(record issuance of 5000 shs.of $5/sh. Stated value)

b) When no par stock does not have a stated value and this
case the entire proceeds from the issue becomes legal capital:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Cash 40,000
Common Stock 40,000
(record issuance of 5000 shs.of no-par stock)

2. ISSUING COMMON STOCK FOR SERVICES OR NONCASH

ASSETS:
Stock may be issued for services, such as compensation to attorneys or
consultants, or for noncash assets, where to comply with the cost
principle, in a noncash transaction; cost is the cash equivalent price.
Since organization costs are expenses when incurred, the following
entry would the issuance of 4,000 shares of $1 par value common
stock to the attorneys who billed the company $5,000 for their services
to organize the corporation:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Organization Expense 5,000
Common Stock 4,000
Paid-in Capital in Excess of Par Value 1,000
(record issuance of 4000 shs.of $1/sh.to
attorneys)

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 When common stock is issued for services or non-cash assets, such as
land, cost is either the fair market value (FMV) of the consideration
given up, or the consideration received, whichever is more clearly
determinable. The par value is never a factor in determining the cost
of the assets received. With the following example, the land was
advertised for $90,000 but that is NOT a FMV as only advertised for
that amount but the current market price of the stock IS CLEARLY
DETERMINABLE as stock is selling for that amount where $5 par
stock is actively trading for $8 per share and the company issued
10,000 shares to acquire the land:

General Journal Page 1

Date Account Title P.R Debit Credit
20--
Mo. Day Land (10,000 x $8) 80,000
Common Stock (10,000 x $5) 50,000
Paid-in Capital in Excess of Par Value 30,000
(record issuance of 10,000 shs.of
$5/sh.for land)

VIII. Accounting for Treasury Stock

A. Treasury stock is a corporation's own stock that has been issued, fully paid
for, and reacquired but not retired. A corporation may acquire treasury stock
in order:
1. To reissue the shares to officers or employees
2. To increase trading thereby enhancing market value
3. To have additional shares available for use in
acquisitions of other companies
4. To reduce the number of shares outstanding and
thereby increase earnings per share
5. To rid the company of disgruntled investors, perhaps to
avoid a takeover.
B. PURCHASE OF TREASURY STOCK—Treasury stock is generally
accounted for by the cost method—uses the cost of the shares purchased to
value the treasury stock (Par value is NOT a consideration when acquiring
treasury stock).
The entry to show Mead, Inc. acquiring 4,000 shares at $8 per share:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Feb. 1 Treasury Stock (4,000 x $8) 32,000
Cash 32,000
(record purchase of 4,000 shs. of treasury
stock for $8/sh.)

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 C. Stockholders’ equity with treasury stock AFTER the purchase of treasury
stock. NOTE (1) the disclosures (par value, shares issued, and shares
outstanding—the number of shares of issued stock that are still held by
stockholders—out in the hands of stockholders) that are required under the
paid-in capital section for the Common Stock and (2) that the acquisition of
treasury stock reduces stockholders’ equity and is shown as the last item
under the stockholders’ equity section just above, “Total stockholders’
equity”:
MEAD, INC.
Balance Sheet (Partial)
Date
Stockholders’ equity:
Paid-in-capital::
Common stock, $5 par value, 100,000 shares
issued and 96,000 shares outstanding $500,000
Retained Earnings 200,000
Total paid-in capital and retained earnings 700,000
Less: Treasury stock (4,000 shares) 32,000
Total stockholders’ equity $668,000

D. DISPOSAL OF TREASURY STOCK—TREASURY STOCK

TRANSACTIONS:
When the Treasury Stock is resold and the selling price of the shares is
greater than cost (Resold above cost), the difference is credited to Paid-
in Capital from Treasury Stock.
Boomer Corporation sells 25 shares of its treasury stick for $18 per share
which was acquired for $15 per share:

General Journal Page 1

Date Account Title P.R Debit Credit
20--
Mo. Day Cash (25 shares x $18/share) 450
Treasury Stock (25 shares x $15/share) 375
Paid-in Capital from Treasury Stock 75
(record sale of 25 shares of treasury stock
at $18/sh. above cost of $15/sh.)

The entry for Mead, Inc. for the sell of treasury stock previously acquired
for $8 per share and is sold for $10 per share:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
July. 1 Cash (1,000 shares x $10/share) 10,000

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 Treasury Stock (1,000 x $8/share) 8,000
Paid-in Capital from Treasury Stock 2,000
(record sale of 1,000 shares of treasury
stock at $10/sh. above cost of $8/sh.)
NOTE: the $2,000 credit in the entry would not be considered a gain on sale of
treasury stock for two reasons: (1) gains on sales occur when assets are sold and
treasury stock is not an asset; and (2) a corporation does not realize a gain or suffer
a loss from stock transactions with its own stockholders. Paid-in Capital from
Treasury Stock will be shown as a separate line item under the Paid-in Capital
section of the stockholders’ equity section of the Balance Sheet as it is an increase to
the corporation’s paid-in capital.

When the selling price is less than cost (Resold below cost), the excess of
cost over selling price is usually debited to Paid-in Capital from Treasury
Stock.
Refer to the entry for Boomer Corporation where Boomer Corporation
sells 25 shares of its treasury stock for $14 per share which was
acquired for $15 per share. Since Paid-in Capital From Treasury
Stock exists and there is a sufficient amount for this entry ($75 from above
entry), the entry is recorded as:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Cash (25 shares x $14/share) 350
Paid-in Capital from Treasury Stock 25
Treasury Stock (25 shares x $15/share) 375
(record sale of 25 shares of treasury stock
at $14/sh. below cost of $15/sh.)

Refer to the entry for Mead, Inc. for the sell of treasury stock previously
acquired for $8 per share and is sold for $7 per share and there is a
sufficient amount for this entry ($2,000 from above entry), the entry is
recorded as:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Oct. 1 Cash (800 shares x $7/share) 5,600
Paid-in Capital from Treasury Stock 800
Treasury Stock (800 x $8/share) 6,400
(record sale of 800 shares of treasury
stock at $7/sh. below cost of $7/sh.)
When there is no remaining balance (Does Not Exist) in Paid-in Capital
from Treasury Stock or not enough for the entry, the remainder is
debited to Retained Earnings. The entry for Mead, Inc. for the sell of the
remaining treasury stock previously acquired for $8 per share and is sold

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 for $7 per share and there is not sufficient amount for this entry (only
$1,200 remaining ($2,000 original entry - $800 used) from the above 2
entries), the entry is recorded as
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Dec. 1 Cash (2,200 shares x $7/share) 15,400
Paid-in Capital from Treasury Stock 1,200
Retained Earnings 1,000
Treasury Stock (2,200 x $8/share) 17,600
(record sale of 800 shares of treasury
stock at $7/sh. below cost of $7/sh.)

IX. Preferred Stock

A. Preferred stock has contractual provisions that give it
priority over common stock in certain areas: distribution of earnings assets
in the event of liquidation.
B. Preferred stockholders usually do not have voting
rights.
C. Preferred stock may have either a par value or no-par
value. Like common stock, preferred stock may be issued for cash or for
noncash assets. The entries are similar as with the issuance of common stock.
Stine Corporation issues 10,000 shares of $10 par value preferred stock for
$12 cash per share recorded as follows where PS is Preferred Stock after the
Paid in Capital in Excess of Par Value as when a corporation has more than
one class of stock, the different paid-in capital in excess accounts must be
distinguished from one another:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Cash (10,000 x $12) 120,000
Preferred Stock (par or legal capital $10.sh.) 100,000
Paid-in Capital in Excess of Par Value-PS 20,000
(record issuance of 10,000 shs.of $10 par
valued preferred stock)

A. Preferred stock is shown first in the stockholders' equity section and should
be identified separately from other stock and paid in capitals. See page 14 of
handouts, chapter 13, of the handout packet—STATEMENT
PRESENTATION OF STOCKHOLDERS’ EQUITY showing that preferred
stock is shown first (with the proper disclosures) in the stockholders’ equity
as well as first in the Additional paid-in capital section.

B. DIVIDEND PREFERENCES—preferred stockholders have the right to

share in the distribution of corporate income BEFORE common
stockholders

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 Cumulative Dividend—A cumulative dividend provides that preferred
stockholders must be paid both current and prior year dividends before
common stockholders receive any dividends.
Preferred dividends not declared in a given period are called dividends in
arrears.
Dividends in arrears are not considered a liability, but the amount of the
dividends in arrears should be disclosed in the notes to the financial
statements.

C. CONVERTIBLE PREFERRED STOCK

Convertible preferred stock provides for the exchange of preferred stock into
common stock at a specified ratio.
Convertible stock is purchased by investors who want the greater security of
a preferred stock, but who also want to be able to capture the market
value of the stock if it increases significantly.
In recording the conversion, the amount paid-in on the preferred stock is
transferred to appropriate common stock accounts (Common Stock and
Paid-in Capital in Excess of Par Value).
Convertible Preferred Stock example—assume that the 1,000 shares of Ross
Industries $100 par preferred are issued at $105 and are converted into
10,000 shares of common stock ($5 par) when the market values per
share of the two classes of stock are $101 and $12, respectively. Note that
the preferred accounts are debited to reduce them to zero. The common
stock is credited for the par value and the remainder will be credited to
the Paid-in Capital in Excess of Par—Common Stock (to balance the
entry) and the market values of the shares at the time of the conversion
are NOT considered. The entry is recorded as follows:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mo. Day Preferred Stock (1,000 x $100) 100,000
Paid-in Capital in Excess of Par Value-PS 5,000
Common Stock (par $5 x 10,000 shs..) 50,000
Paid-in Capital in Excess of Par Value-CS 55,000
(record conversion of 1,000 shs.of $10 par
valued preferred stock)

D. CALLABLE PREFERRED STOCK

Callable preferred stock grants the issuing corporation the right to purchase
the stock from stockholders at specified future dates and prices.
This call feature enables a corporation to eliminate the preferred stock when
it is advantageous to do so.
The call (or redemption) price is frequently above the par or stated value of
the shares.

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 While convertible stock is for the benefit of the stockholder, callable stock is
for the benefit of the corporation.

X. Stockholders’ Equity Presentation and Analysis

A. PRESENTATION—In the stockholders’ equity section of the balance sheet,
paid-in capital and retained earnings are reported. The specific sources of
paid-in capital (sometimes called contributed capital) are identified and the
two classifications are recognized:
Capital stock—STATEMENT PRESENTATION OF STOCKHOLDERS’
EQUITY noting that this category consists of:
Preferred stock first (because of its preferential rights) where par value,
shares authorized, shares issued, and shares outstanding are
disclosed.
Common stock is second where par value, shares authorized, shares
issued, and shares outstanding are disclosed.
Additional paid-in capital which includes:
In excess of par—preferred stock
In excess of par—common stock
From treasury stock if applicable

B. ANALYSIS—BOOK VALUE PER SHARE:

Book value per share represents the equity a common stockholder has in the
net assets of the corporation from owning one share of stock.
The formula for computing book value per share when a corporation has only
one class of stock is:
No. of Common Shares Book Value
Total Stockholder’s Equity ÷ Outstanding = per Share

Computation of preferred stock equity

When a company has both preferred and common stock, the computation
of book value is a bit more complex. Steps required are:
1) Compute the preferred stock equity (the sum of call price of
preferred stock plus any cumulative dividends in arrears). If the
preferred stock does not have a call price, the par value of the
stock is used
2) Determine the common stock equity. Subtract the preferred
stock equity from total stockholders’ equity
3) Divide common stock equity by shares of common stock
outstanding.

C. Book Value versus Market Value

1. Book value per share may not equal market value.
2. Book value is based on recorded costs. Market value reflects the
subjective judgments of thousands of stockholders and prospective

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 investors about the company’s potential for future earnings and
dividends.
3. Market value per share may exceed book value per share, but that
fact does not necessarily mean that the stock is overpriced.
4. Book and market values compared with some companies have large
differences between book value and market range. The correlation
between book value and the annual range of a company’s market value
per share is often remote.
5. Book value per share is useful in determining the trend of a
stockholder’s per share equity in a corporation. It is also significant in
many contracts and in court cases where the rights of individual parties
are based on cost information.

LECTURE NOTES—Accounting for Corporations: Income Reporting

I. DIVIDENDS
 A dividend is a distribution by a corporation to its stockholders on a pro rata
(proportional) basis.
 Dividends may be in the form of cash, property, scrip (promissory note to
pay cash), or stock.
 Dividends may be expressed in one of two ways:
 1) as a percentage of the par or stated value of the stock or
 2) as a dollar amount per share.
A. Cash Dividends—REQUIREMENTS FOR CASH DIVIDENDS:
1. A cash dividend is a pro rata distribution of cash to stockholders. For a
corporation to pay a cash dividend it must have:
a) retained earnings,
b) adequate cash, and
c) a declaration of dividends
2. Entries for Cash Dividends—Three dates are important in connection
with dividends:
a) Declaration date—board of directors formally declares a cash
dividend and a liability is recorded. The declaration of a cash dividend
commits the corporation to a legal obligation that must be recorded. The
account credited, Dividends Payable, is a current liability as it will
normally be paid within the next several months. The account debited can
be Retained Earnings or Dividends if a separate general ledger account is
set up. The entry to record a 50¢ per share cash dividend on 100,000 (.50
x 100,000) shares of $10 par value common stock is recorded as follows:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Dec. 1 Retained Earnings 50,000
Dividends Payable 50,000
(To record declaration of cash dividend).

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 b) Record date— marks the time when ownership of outstanding
shares is determined from the records maintained by the corporation.
No entry is required on this date because the corporation’s liability is
unchanged.
c) Payment date—the date dividend checks are mailed to the
stockholders and the payment of the dividend is recorded. Assuming
the payment date is January 20, the following entry is recorded:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Jan. 20 Dividends Payable 50,000
Cash 50,000
(To record payment of a cash
dividend).
3. Allocating Cash Dividends between Preferred and Common Stock
a) Cash dividends must be paid first to preferred stockholders before
any common stockholders are paid.
b) When preferred stock is cumulative, any dividends in arrears must be
paid to preferred stockholders before allocating any dividends to
common stockholders. The allocation of the dividend to the two classes
of stock as follows:
Total Dividend $50,000
Allocated to preferred stock:
Dividends in arrears, 2008 (1,000 x $2/share dividend) $2,000
2009 dividend (1,000 x $8) 8,000 10,000
Remained allocated to common stock $40,000
To record the declaration the entry would be:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Dec. 31 Retained Earnings 50,000
Dividends Payable 50,000
(To record declaration of cash
dividends of $10,000 to
preferred stock and $40,000 to
common stock).
c) When preferred stock is not cumulative, only the current year’s
dividend must be paid to preferred stockholders before paying any
dividends to common stockholders. The difference would be in the
explanation as follows:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Dec. 31 Retained Earnings 50,000

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 Dividends Payable 50,000
(To record declaration of cash
dividends of $8,000 to preferred
stock and $42,000 to common
stock).
B. Stock Dividends—reasons for stock dividends, summary of stock dividends
and how to account for small and large stock dividends.
1. A stock dividend is a pro rata distribution to stockholders of the
corporation’s own stock and results in a decrease in retained earnings and
an increase in paid-in capital.
2. At a minimum, the par or stated value must be assigned to the dividend
shares; in most cases, however, fair market value is used.
3. A stock dividend does NOT decrease total assets or total stockholders’
equity.
4. Purposes and Benefits of a Stock Dividend: Corporations issue stock
dividends generally for one or more of the following reasons:
a) 1) To satisfy stockholders’ dividend expectations without spending
cash.
b) 2) To increase the marketability of stock by increasing the number of
shares.
c) 3) To emphasize that a portion of stockholders’ equity has been
permanently reinvested in the business and unavailable for cash
dividends.
5. Stock Dividends Distinguished
a)
The accounting profession distinguishes between a SMALL stock (less
than 20-25% of the corporation’s issued stock) and a LARGE stock
dividend (greater than 20-25%).
b) Directors should assign fair market value to SMALL stock dividends
based on the assumption that a small stock dividend will have little
effect on the market price of the shares previously outstanding.
c) Par or stated value per share is normally assigned to a LARGE stock
dividend.
6. Entries for Stock Dividends:
a) Small Stock Dividends: Assume that Medland Corporation has
a balance of $300,000 in retained earnings and declares a 10%
stock dividend on its 50,000 shares of $10 par value common
stock. The current FMV of its stock is $15 per share and the
number of shares to be issued is 5,000 (10% of 50,000). The
amount debited to Retained Earnings is $75,000 (5,000 x $15).
NOTE: Retained Earnings is debited for the FMV (5,000 x $15) of
the stock issued because this is a SMALL stock dividend.
Common Stock Dividends Distributable is credited for the par value
of the dividend shares (5,000 x $10), and the excess is credited to
Paid-in Capital (5,000 x $5). The first entry below shows the

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 declaration and the second entry shows the entry when dividends
are issued:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mon. X Retained Earnings (5,000 x $15 FMV) 75,000
Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par Value 25,000
(To record declaration of 10% stock
dividend).

X Common Stock Dividends Distributable 50,000

Common Stock 50,000
(To record issuance of 5,000 shares in
a stock dividend).
b) Illust.—Statement presentation of common stock dividends
distributable:
MEDLAND CORPORATION
Balance Sheet (Partial)
Date
Stockholders’ equity:
Paid-in-capital::
Common stock $500,000
Common stock dividends distributable 50,000 $550,000
Additional paid-in capital:
Paid-in capital in excess of par value 25,000
Total paid-in capital 575,000
Retained Earnings 225,000
Total stockholders’ equity $800,000

7. Stock Dividend Effects—stock dividends change the composition of

stockholders’ equity because a portion of retained earnings is
transferred to paid-in capital. However, total stockholders’ equity and
the par or stated value per share remains the same:
Stockholders’ equity Before After
Divided Dividend
Paid-in capital:
Common stock, $10 par (5,000 x $10) $500,000 $550,000
Paid-in capital in excess of par value (5,000 x $5) -------- 25,000
Total paid-in capital 500,000 575,000
Retained earnings ($75,000 transferred to Paid-in capital) 300,000 225,000
Total stockholders’ equity $800,000 $800,000
Outstanding shares 50,000 55,000
Book value per share $16.00 $14.55

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NOTE: Because outstanding shares increased, book value per share decreased.

C. Stock Splits—EFFECT OF A STOCK SPLIT ON

STOCKHOLDERS’ EQUITY:
A. A stock split involves the issuance of additional shares to stockholders
according to their percentage ownership.
B. In a stock split, the number of shares is increased in the same proportion
that par or stated value per share is decreased.
C. A stock split has no effect on total paid-in capital, retained earnings, and
total stockholders’ equity.
D. It is not necessary to formally journalize a stock split.
E. The Stockholders’ Equity BEFORE a 2 for 1 Stock Split and AFTER a 2 for 1
Stock Split that both Paid-in capital and Retained earnings remain the same but
the Par value per share decreases with a Stock:
Before After
Stock Stock
Stockholders’ equity Split Effect
Split
Paid-in capital:
Common stock, $10 par (5,000 x $10) $500,000 Same $500,000
Paid-in capital in excess of par value -0- -0-
Total paid-in capital 500,000 500,000
Retained earnings 300,000 Same 300,000
Total stockholders’ equity $800,000 $800,000
Outstanding shares (Increased—doubled) 50,000 Inc. 100,000
Book value per share (Decreased—half as much) $16.00 Dec. $8.00
F. Differences between the effects:
Item Stock Split Stock Dividend
Total paid-in capital No change Increase
Total retained earnings No change Decrease
Total par value (common stock) No change Increase
Par value per share Decrease No change

II. RETAINED EARNINGS

A. Introduction
1. Retained earnings is net income that is retained in the business.
2. The balance in retained earnings is part of the stockholders’ claim on the
total assets of the corporation.
3. A net loss is recorded in Retained Earnings by a closing entry in which
Retained Earnings is debited and Income Summary is credited. A debit
balance in Retained Earnings is identified as a deficit and must be labeled
as such under the stockholders’ equity section of the balance sheet as the
words, “Retained earnings,” can mislead users of the financial statements
that the company does have retained earnings when it DOES NOT and
would be shown as follows:

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 MEDLAND CORPORATION
Balance Sheet (Partial)
Date
Stockholders’ equity:
Paid-in-capital::
Common stock $800,000
Deficit (50,000)
Total stockholders’ equity $750,000

B. RETAINED EARNINGS (RE) RESTRICTIONS:

1. In some cases there may be retained earnings restrictions. These make a
portion of the balance currently unavailable for dividends.
2. Restrictions result from one or more of the following causes:
a) Legal - states may require that corporations restrict RE for the cost of
treasury stock purchased.
b) Contractual - long term debt contracts may restrict RE as a condition
for a loan.
c) Voluntary - the board of directors may voluntarily restrict RE for
specific purposes such as future plant expansion.
3. The balance in retained earnings is generally available for dividend
declarations. Some companies state this fact.
4. Examples of disclosures concerning unrestricted and restricted retained
earnings:
a) An example showing the disclosure of unrestricted retained earnings
was shown in the notes to its financial statements of Lockheed Martin
Corporation.
b) Disclosure of restriction on Tektronix Inc.’s Notes to the Financial
Statements stated the restriction on the payments of dividends was
due to loan (debt) agreements.

C. PRIOR PERIOD ADJUSTMENTS:

1. A prior period adjustment is the correction of a material error
in reporting net income in previously issued financial statements. The
correction is:
a) Made directly to Retained Earnings.
b) Reported in the current year’s retained earnings statement
as an adjustment of the beginning balance of Retained Earnings.
c) To illustrate the entry for a prior period adjustment when a
material error is discovered that understated depreciation expense in
a prior period by $300,000, the following entry would be made noting
that since Depreciation Expense has been closed into Income
Summary which in turn is closed into Retained Earnings that the
debit, therefore, is to Retained Earnings to decrease Retained Earnings
and the credit is to the permanent account that was understated by

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 $300,000—Accumulated Depreciation to increase that account to the
correct balance:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mon. X Retained Earnings 300,000
Accumulated Depreciation 300,000
(To adjust the understatement of
depreciation in a prior period).

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 2. Statement presentation of prior period adjustments for a
correction for overstatement of net income in prior period (depreciation
error) is as follows:
GENERAL MICROWAVE
Retained Earnings Statement (Partial)
For the Year Ended (Date)
Balance, January 1, as reported $800,000
Correction of overstatement of net income in prior
period (depreciation error) (300,000)
Balance, January 1, as adjusted $500,000

D. RETAINED EARNINGS STATEMENT:

1. The retained earnings statement shows the changes in retained earnings
during the year prepared from the Retained Earnings account.
2. Transactions and events that affect retained earnings are tabulated in
account form—Debits and Credits to Retained Earnings as follows with a
Retained Earning T-account:
Retained Earnings
Debits (Decreases) Credits (Increases)
1. Net loss 1. Net income
2. Prior period adjustments for 2. Prior period adjustments for
overstatement of net income understatement of net income
3. Cash dividends and stock dividends
4. Some disposals of treasury stock

E. STATEMENT PRESENTATION AND ANALYSIS:

1. Presentation: Comprehensive stockholders’ equity section noting the
following:
a) In the stockholders’ equity section of a balance sheet, Common Stock
Dividends Distributable is shown under capital stock in paid-in-
capital.
b) Retained earnings restrictions are disclosed in the notes to the
financial statements.

2. Analysis
a) Profitability from the viewpoint of the common stockholder can be
measured by the return on stockholders’ equity. This ratio shows
how many dollars of net income were earned for every dollar
invested by the stockholders.

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 b) It is computed as follows:
“Average” Common
Stockholders’ Equity
Net Income – [(beg. of yr. + end of year ÷ 2) Return on Common
Preferred Dividends ÷ – Par value Preferred Stock] = Stockholders’ Equity
For Kellogg Company’s which does not have preferred stock and
therefore the center portion of the formula is just calculating the
“average” stockholders’ equity:
“Average” Common
Net Income – Stockholders’ Equity Return on Common
Preferred Dividends ÷ (beg. of yr. + end of year ÷ 2) = Stockholders’ Equity
($890.6 - $0) ÷ ($1,443.2+ $2,257.2 ÷ 2) = 48.1%

III. CORPORATION INCOME STATEMENTS with income taxes:

A. Introduction
1. Income statements for corporations are the same as the statements for
proprietorships or partnerships except for one thing: the reporting of
income taxes.
2. For income tax purposes, corporations are a separate legal entity. As a
result, income tax expense is reported in a separate section of the
corporation income statement before net income.
3. Income statement with income taxes showing the Income tax expense
after the Income before income taxes line item.
4. Income tax expense and the related liability for income taxes payable are
recorded as part of the adjusting process where the adjusting for Leads, Inc.
would be entered as followed:
General Journal Page 1
Date Account Title P.R Debit Credit
20-- Adjusting Entry
Dec. 31 Income Tax Expense 46,800
Income taxes Payable 46,800

IV. EARNINGS PER SHARE (EPS)

A. Earnings per share (EPS) indicate the net income earned by each share
of outstanding common stock.
B. Most companies are required to report earnings per share on the income
statement.
C. EARNINGS PER SHARE CALCULATION:
Net Income – “Weighted” Average of
Preferred Dividends ÷ Common Shares Outstanding = Earnings per Share
D. To illustrate, assume Rally Inc. reports net income of $211,000 on its 102,500
weighted average common shares (calculation of weighted average is covered in
advanced accounting courses dealing with days during the year with the number

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 of shares outstanding) and that during the year it also declares a $6,000 dividend
on its preferred stock is calculated as follows:
Net Income – “Weighted” Average of
Preferred Dividends ÷ Common Shares Outstanding = Earnings per Share
$211,000 - $6,000 ÷ 102,500 = $2.00
E. Basic earnings per share disclosure which is simply reported below the net
income on the income statement.
F. Additional earnings per share disclosures are required when the income
statement contains any irregular (non-recurring) items; EPS should be disclosed
for each component. Assuming that Arco Energy had 100,000 shares of
common stock outstanding during the year, the additional EPS disclosures on
the income statement would be shown as follows noting that the dollar amount
in parenthesis are coming from the main part of the income statement:
ARCO ENERGY INC.
Income Statement (partial)
For the Year Ended December 31, 20--
Net income $284,200
Earnings per share:
Income from continuing operations ($560,000 ÷ 100,000) $5.60
Loss from discontinued operations ($210,000 ÷ 100,000) (2.10)
Income before extraordinary item and cumulative
Effect of change in accounting principle ($350,000 ÷ 100,000) 3.50
Extraordinary loss ($49,000 ÷ 100,000) (.49)
Cumulative effect of change in accounting principle ($16,800÷100,000) (.17)
Net income $2.84

V. Price/Earnings Ratio (P/E) is the ratio of the market price of a share of

common stock to the company’s earnings per share (market price per share /
earnings per share). It measures the value that the stock market places on $1 of a
company’s earnings. A higher price/earnings ratio signifies a higher return on
investment and is most useful when comparing one company to another.

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