CHAPTER

BLUE NOTES
36 S
L
Retained earnings represent the cumulative balance of periodic net income or loss, dividend distributions, prior period
errors, changes in accounting policy, and other capital adjustments.

Unappropriated retained earnings represent that portion Appropriated retained earnings represent that portion
which is free and can be declared as dividends to which has been restricted and therefore is not available
shareholders. for any dividend declaration.

Dividends are distributions of earnings or capital to the shareholder in proportion to their shareholdings.

DIVIDENDS OUT OF EARNINGS

 Date of declaration is the date in which the directors authorize the payment of dividends to shareholders.
 Date of record is the date on which the stock and transfer book of corporation will be closed for registration.
Only those shareholders registered as of such date are entitled to receive dividends.
 Date of payment is the date on which the dividend liability is to be paid.
Note: The liability for dividend must be recognized on the date of declaration.

Types of dividends

Cash Dividends Property Dividends Liability Dividends Stock Dividends

Distribution of earnings of Distribution of earnings of These are actually deferred Distributions of earnings of
the entity to the the entity to the cash dividends. It may be in the entity in the form of the
shareholders in the form of shareholders in the form of the form of bond and scrip. entity’s own shares.
cash. cash.

Cash dividends

Date of Declaration: Date of Settlement:

Retained Earnings xx Dividends Payable xx
Dividends payable xx Cash xx
Property dividends
Measurement
 At the fair value of the asset to be distributed.
 At the end of each reporting period and at the date of settlement, the entity shall review and adjust the
carrying amount of the dividend payable with any change recognized in equity as adjustment to the amount of
distribution.
Settlement
 The difference between the carrying amount of the dividend payable and the carrying amount of the asset
distributed shall be recognized in profit or loss.
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.
Liability dividends
 In the form of bond or script dividends.
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Bond Script
Long term Short Term
Normally, interest bearing May or may not be interest bearing

Stock dividends
 Stock dividends or bonus issues are distributions of the earnings of the entity in the form of the
entity’s own shares.
 When stocks dividends are declared, the retained earnings of the entity are in effect capitalized,
meaning transferred to share capital.
Rule
 If the stock dividend is less than 20%, entities whose shares are registered with SEC and are listed in
stock exchange may account for stock dividend by transferring from retained earnings to share
capital and share premium the fair value on the date of declaration (or par or stated value, if higher
than fair value), of the additional shares issued.
 If the stock 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.
Fractional stock dividends
 The entity may issue warrants for the fractional shares and give the holders thereof enough time to
accumulate sufficient warrants for a full share.
 The entity may pay cash in lieu of fractional share. This is possible only if the source of stock
dividends is retained earnings. If the source of stock dividends is share premium, the cash payment is
illegal.

DIVIDENDS OUT OF CAPITAL

 These are also called liquidating dividends which are to be paid to the shareholders when the entity is
dissolved and liquidated. It is illegal to return capital to the shareholders during the lifetime of the
entity. This is in conformance with the trust fund doctrine.
 However, wasting asset corporations may declare dividends which are in part distribution of earnings
and in part distribution of capital. This is in conformity with wasting asset doctrine which holds that a
wasting asset entity can declare dividends not only to the extent of the retained earnings balance but
also to the extent of the accumulated depletion.

EQUITY INSTRUMENT CLASSIFIED AS FINANCIAL LIABILITY

Examples:
a. A preference share that provides for mandatory redemption by the issuer for a fixed or determinable
amount at a future date.
b. A preference share that gives the holder the right to require the issuer to redeem the instrument at a
particular date for a fixed or determinable amount.
Note:
 This is a financial liability of the issuer because the issuer has a contractual obligation to pay cash at some future time.
 Dividends paid to shareholders of “mandatorily redeemable preference shares” shall be accounted for as interest expense a
component of finance cost in the income statement. The mandatorily redeemable preference share shall be presented as current or
noncurrent liability depending on the redemption date.

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APPROPRIATION OF RETAINED EARNINGS

Legal appropriation
This arises from the fact that the legal capital cannot be returned to the shareholders until the entity is
dissolved and liquidated.
Contractual appropriation
This arises from the fact that the terms of the bond issue and preference share issue may impose restriction on
the payment of dividends. This is to ensure the eventual payment of the bonds and redemption of the preference
share.
Voluntary appropriation
This is a matter of discretion on the part of the management. It may arise from the fact that management
wishes to preserve the funds for expansion purposes or for covering possible losses or contingencies.

RESERVES

a. Share premium reserve is the excess over par or stated value.

b. Appropriation reserve is the earmarking of retained earnings for a certain purpose which may be legal, contractual
or voluntary. This is technically known as Retained earnings appropriated.
c. Asset revaluation reserve arises from the revaluation of PPE. It is the excess of fair value or depreciated
replacement cost of the revalued property over its book value. This is technically known as Revaluation surplus.
d. Other comprehensive income reserve

QUASI-REORGANIZATION
It is a permissive but not a mandatory proce3dure under which a financially troubled entity restates its
accounts and establishes a “fresh start” in accounting sense. It is also called “corporate readjustment”. It may be done
through:
 Recapitalization
 Revaluation of PPE
Circumstances that may justify quasi-reorganization:
 When a large deficit exists
 When approved by the shareholders and creditors
 When the cost basis of accounting for PPE becomes unrealistic. 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 its PPE if their current value is substantially more than their cost.
 When s “fresh start” appears to be desirable or advantageous to all parties concerned.

Illustration – thru recapitalization

Assume the following statement of financial position of Purdits Company on January 1, 2013 prior to
quasi-reorganization.

Current assets 1, 000, 000

PPE 7, 500, 000
Accumulated Depreciation 1, 000, 000 6, 500, 000
7, 500, 000

Liabilities 4, 500, 000

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142 USL Blue Notes Chapter 36 – Retained Earnings

Share capital, 100 par, 50, 000 shares 5, 000, 000

Retained earnings (deficit) (2, 000, 000)
7, 500, 000

On January 1, 2013 the shareholders and creditors agreed to quasi-reorganization. Accordingly, the
following restatements should be made:
 The PPE shall be recorded at the fair value of 6, 000, 000
 The inventory is overvalued to the extent of 250, 000 and shall be revalued accordingly
 The share capital is reduced to 2, 000, 000, 20, 000 shares, 100 par value
 The resulting deficit is charged to the share premium arising from the reorganization.

Adjusting entries are:

Accumulated depreciation 1, 000, 000
Retained earnings 500, 000
PPE 1, 500, 000

Retained earnings 250, 000

Inventory 250, 000

Share capital 3, 000, 000

Share premium 3, 000, 000

Share premium 2, 750, 000

Retained earnings 2, 750, 000
(To eliminate the deficit in the retained earnings)

Illustration – thru revaluation

Ajitjit Company has sustained heavy losses over a period of time and conditions warrant that Ajitjit
Company undergoes quasi-reorganization on December 31, 2013.
The statement of financial position of Ajitjit Company prior to reorganization is:

Current assets 1, 000, 000

PPE 5, 000, 000
Accumulated depreciation 1, 500, 000 3, 500, 000
Goodwill 100, 000
Total Assets 4, 600, 000

Current liabilities 1, 100, 000

Share capital, 10 par 5, 000, 000
Share premium 500, 000
Retained earnings (deficit) (2, 000, 000)
Total Liabilities and SHE 4, 600, 000

The SEC approves the quasi-reorganization on the basis of the unrealistic valuation of the PPE.
Accordingly, the SEC recommended that the PPE be revalued by an independent expert.
 The PPE are determined to have replacement cost of 9, 000, 000

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 The inventory be written down by 400, 000

 The goodwill is to be written off
 Unrecorded accounts payable amounted to 200, 000
 Any resulting deficit is charged against revaluation surplus.

Adjusting entries are as follows:

PPE 4, 000, 000
Accumulated depreciation 1, 200, 000
Revaluation surplus 2, 800, 000

Cost Replacement cost Appreciation

PPE 5, 000, 000 9, 000, 000 4, 000, 000
Accum. Depreciation (30%) 1, 500, 000 2, 700, 000 1, 200, 000
3, 500, 000 6, 300, 000 2, 800, 000

Retained earnings 400, 000

Inventory 400, 000

Retained earnings 100, 000

Goodwill 100, 000

Retained earnings 200, 000

Accounts payable 200, 000

Revaluation surplus 2, 700, 000

Retained earnings 2, 700, 000
(To eliminated the deficit)

Other illustrations:
Case 1
Mamabear Company had the following shareholder’s equity account balances on January 1, 2010:

Preference share capital, 100 par, 10% cumulative 2, 000, 000

Ordinary share capital, no par, 5 stated value 5, 150, 000
Share premium 3, 500, 000
Retained earnings 4, 000, 000
Treasury share ordinary 400, 000

Transactions during 2010 and other information were:

 On January 15, 2010, Mamabear Company formally retired all the 30, 000 treasury shares. The treasury
shares were acquired in January 2009. The shares were originally issued at 10 per share.
 Mamabear owned 10, 000 shares of Papabear Company purchased in 2009 for 800, 000. The Papabear
shares were included in Mamabear’s noncurrent securites. On December 31, 2010, Mamabear declared a
dividend in king of one share of Papabear for every hundred ordinary shares of Mamabear held by
shareholders. The fair value of the Papabear shares is 90 on December 31, 2010. The dividend in king was
distributed on March 15, 2011 when then fair value of Papabear’s share is 100.

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144 USL Blue Notes Chapter 36 – Retained Earnings

 On December 31, 2010, Mamabear declared yearly cash dividend on preference share, payable on January
15, 2011.
 On January 15, 2011, before the accounting records were closed for 2010, Mamabear became aware that
rent income for the year ended December 31, 2009 was overstated by 1, 000, 000. The after-tax effect on
2009 net income was 700, 000. After correcting the rent income, the net income for 2010 was 3, 000, 000.

What is the adjusted balance of retained earnings on December 31, 2010?

Retained earnings – January 1, 2010 4, 000, 000

Excess of cost of treasury over issue price
(400, 00- 300, 000) (100, 000)
Property dividend of Papabear’s share (10, 000x 90) (900, 000)
Preference dividend (10% x 2, 000, 000) (200, 000)
Overstatement of 2009 rent income – net of tax (700, 000)
Net income for 2010 3, 000, 000
Retained earnings – December 31, 2010 5, 100, 000

Case 2
Bergite Company was organized on January 1, 2008. After 2 years of profitable operations, the equity section
of the statement of financial position was as follows:

Contributed capital:
Share capital, 5 par, 600, 000 share authorized,
200, 000 shares issued and outstanding 1, 000, 000
Share premium 6, 000, 000
Retained earnings 2, 800, 000
Total SHE 9, 800, 000

During 2010, the following chronological transactions affected shareholders’ equity:

 Reacquired 10, 000 shares at 30 per share to be help as treasury
 Declared and issued a 30% stock dividend
 Declared and paid cash dividend of 10 per share
 Net income for 2010 amounted to 3, 000, 000

What is unappropriated balance of retained earnings on December 31, 2010?

Retained earnings – January 1, 2010 2, 800, 000

Stock dividend (57, 000 x 5) (285, 000)
*Cash dividend (247, 000 x 10) (2, 470, 000)
Net income 3, 000, 000
Appropriated for treasury shares (10, 000 x 30) (300, 000)
Unappropriated balance – December 31, 2010 2, 745, 000

*Shares issued – January 1, 2010 200, 000

Treasury shares (10, 000)
Outstanding shares 190, 000

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Stock dividend (30% x 190, 000) 57, 000

Total outstanding shares 247, 000

Case 3
On November 1, 2010, Yourface Company declared a property dividend of equipment payable on
March 1, 2011. The carrying amount of the equipment 3, 000, 000 and the fair value is 2, 500, 000 on
November 1, 2010.
However, the fair value less cost to distribute the equipment is 2, 200, 000 on December 31, 2010 and
2, 000, 000 on March 1, 2011.

What is the dividend payable on December 31, 2010?2, 200, 000

To recognize the dividend payable on November 1, 2010

Retained earnings 2, 500, 000
Dividends payable 2, 500, 000

To recognize the decrease in dividend payable on December 31, 2010

Dividends payable 300, 000
Retained earnings 300, 000

What is the measurement of the equipment on December 31, 2010? 2, 200, 000

Carrying amount 3, 000, 000

Fair value less cost to distribute 2, 000, 000
Impairment loss 800, 000

Impairment loss 800, 000

Equipment 800, 000

What amount of loss is recognized in profit or loss on March 1, 2011? 200, 000

Fair value – March 1, 2011 2, 000, 000

Fair value – December 31, 2011 (2, 200, 000)
Decrease in dividend payable (200, 000)

Dividend payable 200, 000

Retained earnings 200, 000

Dividends parable – March 1, 2011 2, 000, 000

Carrying amount of equipment – December 31, 2010 (2, 200, 000)
Loss on distribution of property dividend (200, 000)

Dividend payable 2, 000, 000

Loss on distribution of property dividend 200, 000
Equipment 2, 200, 000

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