RETAINED EARNINGS

1. Define retained earnings

 Retained earnings represent the cumulative balance of periodic net income or loss, dividend distributions,
prior period errors, effects of change in accounting policy and other capital adjustments
 Under IAS, the term for retained earnings is accumulated profits
 When the retained earnings account has a debit balance, it is called a “deficit”
 A deficit is not an asset but a deduction from shareholders’ equity. The IAS term for deficit is “accumulated
losses”
 Retained earnings can be classified into two namely:
a. Unappropriated retained earnings represent that portion which is free and can be declared as dividends
to stockholders
b. Appropriated retained earnings represent that portion which is restricted and therefore not available for
any dividend declaration
2. What are dividends?
 Dividends are distribution of earnings or capital to shareholders in proportion to their shareholdings
 Dividends out of earnings can be declared, only from retained earnings
 If the entity has a deficit, it is illegal to pay dividends
 The common forms of dividends out of earnings are cash dividend, property dividend and share dividend
 Dividends out of capital are distributions of capital to shareholders in proportion to their shareholdings
 Such dividends are popularly known as liquidating dividends
3. When are dividends recognized?
 Under IFRIC 17 “Distribution of noncash assets to owners” paragraph 10, the liability to pay dividend shall be
recognized when the dividend is appropriately authorized and is no longer at the discretion of the entity,
which is the date:
a. When the dividends is declared by management or the board of directors if the local jurisdiction does
not require further approval
b. When the declaration of dividend by management or the board of directors is approved by relevant
authority, for example, the shareholders, if the local jurisdiction requires such approval
 Simply stated, the liability for dividend must be recognized on the date of declaration
4. Explain property dividends
 Property dividends or dividends in kind are distribution of earnings to the shareholders in the form of
noncash assets
 IFRIC 17, paragraph 11 provides that an entity shall measure a liability to distribute noncash asset as a
dividend to owners at the fair value of the asset to be distributed
 Paragraph 13 provides that the dividend payable is initially recognized at fair value of the noncash asset on
date of declaration and is increased or decreased as a result of the change in fair value of the asset at every
year-end and date of settlement
 The offsetting debit or credit is through equity or directly retained earnings
 Paragraph 14 provides that when an entity settles the dividend payable, the difference between the carrying
amount of the noncash asset distributed shall be recognized in profit or loss
 PFRS 5, Paragraph 15A, provides that an entity shall measure a noncurrent asset classified for distribution to
owners at the lower of carrying amount and fair value les cost to distribute
 Accordingly, if the fair value less cost to distribute is lower than the carrying amount of the asset at the end
of the reporting period, the difference is accounted for as impairment loss
5. What is a share dividend?
  The IAS term for share dividend is “bonus issue”
 Share dividend is distribution of the earnings of the entity in the form of the entity’s own shares
 When share dividend is declared, the retained earnings of the entity are in effect capitalized or transferred
to share capital
 The assets of the entity remain the same before and after the issuance of the share dividend
 Share dividend payable is not a liability but an addition to the share capital in the shareholders’ equity
6. When share dividends are declared, what amount of retained earnings should be capitalized or what amount
should be debited to retained earnings?
 The IFRS does not address share dividends
 Thus the guidance is based on the Philippine GAAP in accounting for share dividends
a. If the share dividend is 20% or more, the par or stated value is capitalized or debited to retained
earnings. If the share dividend is 20% or more, the par or stated value is capitalized because this is
conceived to materially effect a reduction in the share market value. Share dividends of 20% or more is
considered as large share dividend
b. If the share dividend is less than 20% the fair value of the share on the date of declaration is capitalized.
However, if the fair value is lower than the par or stated value, the par or stated value is capitalized. If
the fair value is higher than par or stated value, the difference is credited to share premium from share
dividend. Share dividend of less than 20% is considered a small share dividend
7. What is quasi-reorganization?
 A quasi-reorganization is the procedure of restating assets, liabilities and capital in conformity with fair value
for the purpose of eliminating a deficit
 A quasi-reorganization may be accomplished through recapitalization and revaluation.
 If done through recapitalization, the deficit is eliminated against the share premium from recapitalization
 If done through revaluation, the deficit is eliminated against the revaluation surplus

Circumstances that may justify quasi-reorganization

a. When large deficit exists
b. When approved by the shareholders and creditors
c. When the cost basis of the accounting for property, plant and equipment becomes unrealistic
d. When a “fresh start’ appears to be desirable or advantageous to all parties concerned

 An entity in financial difficulty may be permitted by the SEC to undergo a quasi-reorganization and in the
process may be allowed to revalue property, plant and equipment if current value is substantially more than
cost
 Retained earnings subsequent to quasi-reorganization shall be restricted to the extent of the deficit wiped
out during the reorganization and cannot be declared as dividend
 Losses subsequent to quasi-reorganization cannot be charged to the remaining revaluation surplus
 The quasi-reorganization shall be disclosed for at least 3 years.

Direction: Read and encircle the letter which corresponds to the correct answer

1. Nonstock dividends shall be recognized as liability on the

a. Date of declaration
b. Date of record
c. Date of payment
d. Date of issuing check
2. Treasury shares may be reissued as dividends, in which case what amount should be charged to retained
earnings?
a. Cost of the treasury shares
 b. Par value of the treasury shares
c. Fair value of the treasury shares on the date of declaration
d. Fair value of the treasury shares on the date of issuance
3. If the share dividend is less than 20%, what amount of the retained earnings should be capitalized?
a. Par value of the shares
b. Fair value of the shares on the date of declaration
c. Fair value of the shares on the date of record
d. Fair value of the shares on the date of issuance
4. In closely held entities, if share dividends are declared, retained earnings shall be capitalized at
a. Par or stated value
b. Book value
c. Fair value on date of declaration
d. Fair value on date of issue
5. An entity shall measure a liability to distribute noncash asset as dividend to the owners at
a. Carrying amount of the asset distributed
b. Fair value of the asset distributed
c. Either the carrying amount or fair value of the asset
d. Neither the carrying amount nor fair value
6. An entity shall measure a noncurrent asset classified as held for distribution to owners at
a. Carrying amount
b. Fair value less cost to distribute
c. Lower of carrying amount and fair value less cost to distribute
d. Fair value
7. The actual total amount of a cash dividend to be paid is determined on the date of
a. Record
b. Declaration
c. Declaration or date of record, whichever is earlier
d. Payment
8. A retained earnings appropriation is used to
a. Absorb a fire loss when an entity is self-insured
b. Provide for a contingent loss that is probable and measurable
c. Smooth periodic income
d. Restrict earnings available for dividends
9. A restriction of retained earnings is most likely to be required by
a. Purchase of property, plant and equipment
b. Purchase of treasury shares
c. Payment of last maturing series of a serial bond issue
d. Funding of past service cost
10. Which statement is true concerning appropriations of retained earnings?
a. Appropriations do not reduce total retained earnings
b. The only proper way to eliminate an appropriation of retained earnings after it has served its purpose is to
revert to the unappropriated retained earnings
c. When treasury shares are purchased, retained earnings must be appropriated equal to the cost of the
treasury shares
d. All of these statements are true concerning appropriations of retained earnings