Intermediate Financial Accounting

Shareholders' EquityRetained Earnings
by Professor Hsieh

Objectives of the Chapter

To discuss the content of retained earnings. To study the accounting treatments for dividends (including cash dividend, property dividend, scrip dividend, and stock dividend). To learn the procedures for quasireorganization.
Stockholders' Equity (2)- Retained Earnings 2

Content of Retained Earnings

Stockholders’ equity consists of primarily stockholders’ investments (i.e., contributed capital) and retained earnings. The primary factors that affect retained earnings besides net income (or net loss) include (1) dividends, (2) prior period adjustments, (3) appropriations, and (4) quasi-reorganizations.
Stockholders' Equity (2)- Retained Earnings 3

a company must meet legal requirements and have assets available for distribution.Dividends   While the net income increases the retained earnings. Stockholders' Equity (2).Retained Earnings 4 . the distribution of dividends reduces the retained earnings. In order to declare dividends.

* *Note: as long as the total assets after dividends equal or exceed the sum of total liabilities and the amount needed to satisfy the rights of other classes of shareholders with higher priority in receiving assts at liquidation (Revised Model Business Corporation Act.Retained Earnings 5  ..e. dividends pay out of contributed capital). most states allow liquidating dividends (i.)   Most companies regard the unrestricted retained earnings as the limit for dividends distribution. However.Dividends (contd. 1994). Stockholders' Equity (2).

Dividends (contd. Stockholders' Equity (2). restrict the use of retained earnings for dividends.Retained Earnings 6 .)  Restrictions of retained earnings include:  1) Legal restrictions: Many states require a corporation to restrict the cost of treasury stock from dividends distribution. and therefore.  2)Contractual restrictions: A long-term bond contract may limit the use of assets for payment of dividends as a loan condition.

timing and types of dividends to be declared.) 3)Voluntary restrictions: Appropriation of retained earnings for specific purposes.  Stockholders' Equity (2).Dividends:(contd.) Restrictions (contd.Retained Earnings 7 .  The board of directors is responsible for the establishment of dividend policy and the determination of the amount.

(3) scrip. property and scrip dividends decrease retained earnings (R/E) and the stockholders’ equity. (2) property.Dividends:(contd. (4) stock. Cash. Stockholders' Equity (2).)   A few types of dividends may be considered: (1) cash.Retained Earnings 8 . and (5) liquidating dividends.

So.Dividends:(contd.)   Stock dividend decreases R/E but increases contributed capital in the same amount. Stockholders' Equity (2). there is no change in the total stockholders’ equity. Liquidating dividend decreases both contributed capital and the stockholders' equity.Retained Earnings 9 .

Cash Dividends  A cash dividend is the most common type of dividend. and 4) the date of payment. Stockholders' Equity (2). 3) the date of record.Retained Earnings 10 .  Four days are relevant to the cash dividend: 1) the date of declaration. 2) the ex-dividend date.

the board of directors declares preferred dividends totaled $10. 3.000.Retained Earnings 11 . The journal entries for the declaration and other related events are: Stockholders' Equity (2). the ex-dividend date is 11/20/x5. 20x5.)   Example: on Nov. These dividends are payable on 12/15/x5 to stockholders of record on 11/24/x5. In addition.000 and common dividends totaled $20.Cash Dividends:(contd.

 Companies are legally liable for declared dividends on this date.) 11/3/x5 the date of declaration Retained Earnings 30.Retained Earnings 12 .Cash Dividends:(contd.000 Dividends Payable: CS 20.000 Dividends Payable: PS 10.000  Shares are traded with dividends attached after this date.  Stockholders' Equity (2).

)    11/20/x5 Ex-dividend date.Retained Earnings 13 . No entry or memo. a decline in price equals the dividend declared in general occurs on this date.Cash Dividends:(contd. It is usually 4 business dates prior to the date of record. Stockholders' Equity (2). Shares purchased on or after this date are purchased ex dividend-without the right to receive the declared dividend. Therefore.

Cash Dividends:(contd.  Stockholders' Equity (2).  Stockholders on the record will be paid of dividend even if they sell those shares prior to 12/15/x5. the date of record. the payment date.) 11/24/x5 The date of record Memo: the company will pay dividends on 12/15/x5 to preferred and common stockholders of record as of today.Retained Earnings 14 .

)  12/15/x5 Dividend payment date Div.000 Div.Retained Earnings 15 .000 Stockholders' Equity (2). Payable: Com.stk 10.Cash Dividends:(contd.000 Cash 30. stk 20. Payable: Prefer.

Preferred Stock Characteristics  Preferred stockholders have a preference to dividends.  A preference to dividends does not guarantee a dividend distribution.  Stockholders' Equity (2).Retained Earnings 16 . Because a dividend declaration is at the discretion of the board of directors.

Preferred Stock Characteristics (contd. Stockholders' Equity (2). or declares a dividend which is less than the stated rate of the preferred stock. the "passed" dividend of non-cumulative preferred stock will never be paid.Retained Earnings 17 .)  If a corporation fails to declare a dividend.

Cumulative Preferred Stock    For cumulative preferred stock. the amount of passed dividend becomes "dividend in arrears”.Retained Earnings 18 . Common stockholders cannot be paid any dividend until the preferred dividend in arrears has been paid. Stockholders' Equity (2). The “dividend in arrears” has the highest priority to be paid in the following periods.

Stockholders' Equity (2).Cumulative Preferred Stock   Dividend in arrears accumulate from period to period. The “dividend in arrears” is not a liability because no liability exists until the dividend declaration.Retained Earnings 19 .

000.S.000= $3. @$5 Preferred STK outstanding : 5. @$10.000/10.Retained Earnings 20 .000. = ($10. dividend is 6% of the par value Dividends for P. Dividends for C.7 per share ($7.000 shares) Stockholders' Equity (2).Examples Cumulative Preferred Stock Year 1: Case I: Dividends declared = $10.000 Com.000-3. Or $0.000)=$7. STK shares outstanding: 10.000.000. = 6% *10*5.S.

Div. the $2.) Cumulative Preferred Stock Case II: Same information as in Case I except that dividends declared = $1.000-1.000.000 ($3. = $1.000 will never been paid.000.S.S. Passed=$2.S. If this is a non-cumulative P. the dividends in arrears equal $2.000).S. Stockholders' Equity (2).Retained Earnings 21 . = $0 If this is a cumulative P. Dividends for P.000 Dividends for C.Examples (contd..

000.000 (div.000 = $3.Retained Earnings 22 . => $2.S.S. In arrears) $3. Of year 2) $ 5. assuming a cumulative preferred stock and the dividends declared = $8.000. => $8.000 Stockholders' Equity (2).) Cumulative Preferred Stock Year 2: Continued from Case II of year 1.Examples (contd. Dividends for P.$2.000-3.000 Dividends for C.000 (div.

Stockholders' Equity (2).Equal % of dividends as the preferred stock's stated dividends for common stock. preferred stockholders share with the common stockholders in any "extra" dividends. "Extra" dividends = the declared dividends .Retained Earnings 23 .the stated dividends of preferred stock .Participating Preferred Stock   When preferred stock is participating.

)  Fully participating preferred stock: preferred stockholders share equally with the common stockholders in any "extra" dividends.Participating Preferred Stock (contd. based on the respective par value of each class of stock. Stockholders' Equity (2).Retained Earnings 24  . These extra dividends are distributed proportionally.

Participating Preferred Stock (contd. Stockholders' Equity (2). but its participation is limited to a fixed rate or amount per share.)  Partially participating preferred stock: preferred stockholders share in "extra" dividends with common stockholders.Retained Earnings 25 .

any "dividend in arrears" . Stockholders' Equity (2). calculation needs to be made for the allocation of dividends.the stated dividend of the preferred stock If the preferred stock is participating in extra dividends.Retained Earnings 26 . the amount of dividends received by the common stockholders equals: the declared dividends .Allocation of Declared Dividends   If the preferred stock is Not participating.

Retained Earnings 27 .Participating Preferred Stock :(contd. Thus.000 and common stock with a total par value of $30.000.000. and there are no dividends in arrears. preferred stock constitutes 40% and common stock 60% of the total par value.)  Example: Assume a company issued 10% participating cumulative preferred stock with a total par value of $20. The dividend distribution is as follows: Stockholders' Equity (2). The company intends to distribute cash dividends of $9.

) (A) Preferred stock is fully participating: 1.Retained Earnings .000 par) 2.400 28 Stockholders' Equity (2). 10% dividend to preferred (on $20.000 Dividends to each class of stock Preferred $2.600 $3.000 Common $3.000 + 3. Common dividends (equal to 10% of par) Total to allocate $9.000) Extra Dividend (40% to preferred and 60% to common) $4.400 $5.000 Allocated (2.000 Extra dividend proportionate to par values: $1.600 2.Participating Preferred Stock :(contd.000) (5.

600  If any preferred stock dividends had been in arrears. Stockholders' Equity (2).Participating Preferred Stock :(contd. 2% div. 2% div.000-3. Remainder to common (9. Common div.000 2.Retained Earnings 29 .000) 400 4. On par of common (2% * 30. 10% dividend to preferred $2. the dividends in arrears would have been distributed before any participation calculations. (equal to 10%) 3.000-400-600) _____ 3. On par of preferred (2% * 20.400 6.) (B) Preferred Stock Participates up to 12%: Preferred Common 1.000) 600 5.000 Dividends to each class of stock 2.000-2.000 3.

Because they are more easily distributable to the stockholders.   Stockholders' Equity (2).Retained Earnings 30 . Marketable securities are typically used for a property dividend.Property Dividends  A property dividend is that dividend is payable in assets other than cash.

Retained Earnings 31 . par. A gain or a loss is recognized (APB opinion no.Property Dividends  A property dividend is recorded at the fair market value of the asset transferred on the date of declaration. 29. 18).  Stockholders' Equity (2).

000 but the current market value on the declaration date is $48. Aron declares a property dividend. The bonds are carried on Aron’s book at a book value of $40.Property Dividends :(contd.Retained Earnings 32 .000. The journal entries to record the property dividend are as follows: Stockholders' Equity (2). payable in bonds of Rock company being held to maturity.) Examples: (A)Property dividend is an investment in debt held to maturity:  Corp.

000 Stockholders' Equity (2). Retained Earnings 48.000 Investment in Rock Company Bonds 48.000 Property Dividends Payable 48.000 .) Date of Declaration 1.Property Dividends :(contd.000 8. Investments in Rock Company Bond Gain on Disposal of Investment 2.Retained Earnings 33 8.000 Date of Payment Property Dividends Payable 48.

000 and was reported as an asset at a fair value of $29. Stockholders' Equity (2).Retained Earnings 34 .Property Dividends :(contd. The Welch stock had been purchased early in 20x4 for $24. Payable in Welch company stock.) (B) Property dividend is an investment in equity securities “available for sale”: The Remley company declares a property dividend on 3/15/x5.000 on 12/31/x4 balance sheet.

prior to the recog. Of dividends payable: Fair Value Adjustment 2.Property Dividends :(contd. The following entries are made on 3/15/x5 (the declaration date): Adj.000 Unrealized holding gain 2.000 Gain on Disposal of Investment 7.000 on 3/15/x5.000 Stockholders' Equity (2).000 Unrealized holding gain 7.Retained Earnings 35 .)   The market value of Welch stock is $31.

000 7.) J.000 31.000 31.Property Dividends :(contd. on the declaration date: Retained Earnings Property Dividends Payable J.000 24.000 Stockholders' Equity (2).E. on the payment date: Property Dividends Payable Investment in SAS Fair value adjustment 31.E.Retained Earnings 36 .

That is the corporation issues promissory notes (called “scrip”) requiring the Corp.Scrip Dividends   A corporation with adequate retained earnings to meet legal dividend requirements but with insufficient funds to pay a current cash dividend may declare a scrip dividend.Retained Earnings 37 . Stockholders' Equity (2). to pay dividends at some future date.

)  On the declaration date. the following entry will be made:  Retained Earnings xxx Dividends Payable (or Notes Pay.Scrip Dividends :(contd.Retained Earnings 38 .) xxx On the date of Payment: Dividends Payable xxx Interest Expense xxx Cash xxx * If the promissory notes are interest bearing Stockholders' Equity (2).

Each stockholder maintain the same percentage of ownership as before.Retained Earnings 39 . no corporate assets are distributed.Stock Dividends     A stock dividend is a pro rata (proportional) distribution of additional shares of a corporations own stock to its shareholders. Stock dividend is similar to a stock split. When a stock dividend is distributed. Stockholders' Equity (2).

Stockholders' Equity (2).) Accounting treatment: a.Retained Earnings 40 .Stock Dividends (contd. Small stock dividend ( less than 25% of outstanding shares): the stock dividends are accounted for by transferring from retained earnings to contributed capital an amount equals to the fair market value of the additional shares issued.

Stockholders' Equity (2).) b. not the market value of the stock. A large stock dividend (no change in par value per share and is referred to as a stock split effected in the form of stock dividends): the accounting treatment is only to capitalize the par value of the stock.Stock Dividends :(contd.Retained Earnings 41 .  For example. a 100% stock dividend is equivalent to a two-for-one stock split regards to its impact on stock price and share outstanding.

)  Example 1: Small Stock Dividend A Corporation with 20. the stock is selling for $23 per share with a par value of $10 per share. On the date of declaration. The journal entry to recorded the stock dividend is : Stockholders' Equity (2).Retained Earnings 42 .000 shares outstanding declares and issues a 10% stock dividend.Stock Dividends :(contd.

000 Date of Issuance: C.Stock Dividends :(contd.Retained Earnings . Stockholders' Equity (2). To be Distributed C.000 20.000 43 ** reported as a component of contributed capital.S.S.)  Date of Declaration: Retained Earnings 46.000 26. $10 par 20.S. To be Distributed ** Additional Paid-in Capital from Stock Dividend  20.000 C.

Stockholders' Equity (2).000 * An alternative account is retained earnings. If R/E is debited. the accounting standard does not prevent the capitalization of a larger amount per share.Stock Dividends :(contd.Retained Earnings 44 .000** C.)  Example 2: Large Stock Dividend Similar to example 1 except that the stock dividend increases from 10 % to 40% of the shares outstanding: Date Declaration: Additional paid in Capital* 80.S to be Distributed 80.

$10 par  80. Stockholders' Equity (2).) ** $10*(40% *20.S.000 Reason of debiting paid-in capital rather than R/E for large stock dividends: to prevent transferring earned capital to invested capital.000 shares)  Date of Issuance: C.Stock Dividends :(contd.Retained Earnings 45 .S to be Distributed C.000 80.

Stockholders' Equity (2).Fractional Shares A stock dividend or a stock split often results in some shareholders being entitled to fractions of whole shares (fractional shares).Retained Earnings 46 . Cash payments (based on the fair value at declaration) are made to shareholders with fractional shares.

assets which are not subject to a superior claim by creditors. R/E).Liquidating Dividends  Liquidating dividends are a return of contributed capital to stockholders rather than a distribution of earned capital (i.Retained Earnings 47   . Stockholders' Equity (2).e. This may occur in the case of insolvency and assetsa are distributed to stockholders. a. The liquidating portion of the dividend is debited to Additional Paid-in Capital..

and c.Prior Period Adjustments (Restatements) Items reported as prior period adjustments of retained earnings include: a. certain change in accounting treatment (when a retroactive approach is used).Retained Earnings 48 . corrections of errors of prior periods. b. a change in accounting entry.  Stockholders' Equity (2).

the correct entries are: 1. The income tax effect is $3. Income Tax Refund Rece.Prior Period Adjustments (Restatements) Example: In 20x5.000 Retained Earnings 3.000. Retained Earnings 10.000 of interest expense for 20x4. 3.000 2.000  Stockholders' Equity (2).Retained Earnings 49 .000 Interest Payable 10. Fox Company discovered that it did not accrue $10.

000) Adjusted Retained Earnings. 20x5 $95.)  Presentation on the Retained Earnings Statement: R/E.400 Stockholders' Equity (2).Retained Earnings 50 . Jan 1.400 Less: Correction of overstatement in 20x4 N/I due to interest expense understatement (Net of $3.Prior Period Adjustments (Restatements) :(contd.000 I/T) (7. as previous reported Jan 1. 20x5 $102.

Stockholders' Equity (2). This appropriated amount is not available for dividends.Retained Earnings 51  .Appropriation of Retained Earnings  An appropriation (or restriction) of retained earnings is that the board of directors has "earmarked" a portion for the retained earnings (the appropriated amount) for a designated purpose.

Appropiraion of Retained Earnings (contd. (1) Legal requirements: certain states require restrictions of R/E when treasury stock is acquired.Retained Earnings 52 . (2) to meet contractual restrictions.  Stockholders' Equity (2).) Reasons of appropriations: (1) to meet legal requirements.(3) a discretionary action of the board of directors.

) (2) Contractual agreement: due to issue of long-term bonds.000 of retained earnings is appropriated for treasury stock: Stockholders' Equity (2). Example: Assume $2. (3) A discretionary action: based on the needs of the corporation.Retained Earnings 53 .Appropiraion of Retained Earnings (contd.


Appropiraion of Retained Earnings

Retained Earnings 2,000 Retained Earnings: Appropriated for Treasury Stock 2,000  After the treasury stock is reissued, the board of directors would cancel the appropriation: R/E Appropriated for Treasury stock 2,000 Retained earnings 2,000
Stockholders' Equity (2)- Retained Earnings 54

Other Component of Stockholder's Equity
Accumulated Other Comprehensive Incomea: Other Comprehensive income accumulated over the current (reported in the combined income statement) and prior periods. a. Comprehensive income: changes in equity other than from owner related transactions (i.e., additional investment and
dividends distribution).
Stockholders' Equity (2)- Retained Earnings 55

Other Component of Stockholder's Equity (contd.)
 Comprehensive income includes: Net income Other Comprehensive Income (all net of tax): Unrealized gain (loss) from SAS Foreign currency translation adjustments Minimum Pension liability adjustment Deferred gain (loss) from derivatives
Stockholders' Equity (2)- Retained Earnings 56

000 40.000 14.600 263. the cost of the Stockholders' stock. Retained Earnings treasury Equity (2)- 57 .000 shares authorized.200 689. unrealized capital. 11.000) 686.000.000 197.400 5.600 (11.000) 3. $5 par (30.400 shares issued. 20x5 Contributed capital: Common stock .000 386. and retained earnings Less: Treasury stock (at cost) Total stockholders' equity 57.Example of Stockholders’ Equity and Statement of Changes in Stockholders’ Equity  KARDWELL CORPORATION Stockholders’ Equity December 31.200 Note: R/E are restricted regarding dividends in the amount of $3. of which 100 shares are being held treasury stock) Additional paid-in capital on common stock Additional paid-in capital from treasury stock Common stock option warrants Less: Deferred compensation Total Contributed capital Accumulated Other Comprehensive Income Unrealized gain from valuation of SAS Retained earnings (see note) Total contributed capital.200 (3.

000 2700 300 1. 1/1/95 Issued for cash Reissued treaury stock Issued for exercise of stock options Compensation expense for stock options Compensation cost for new stock options Unrealized gain from valuation of SAS Net income Cash dividends Balances.000 2.100 Par Value 50.400) 10.400 (900) 4.200 (3.000 5.000 1.300) 30.000 (32.000) Shares Issued 10.000 197.Retained Earnings 58 .500 Additional Paid-in Capital Common Stock Accum. Other Retained Earnings 322. Stock Stock Warrants Compensation Income 170.000) Stockholders' Equity (2).500 5.400 57.400 5.600 (11.000 Treasury Stock (Cost) (7.200 (8.Example of Stockholders’ Equity and Statement of Changes in Stockholders’ Equity: (Contd.300 (3.300 12.000 386.800) 40.)  Statement of Changes in Stockholders’ Equity for Year Ended December 31.000 14.500 700 3. 12/31/95 11.000 22. 20x5 Common Stock Explanation Balances.500) Common Treasury Option Deferred Compre.000 97.

that involves a revaluation of corporate assets and liabilities.Quasi-Reorganization  A quasi-reorganization is primarily an accounting procedure. Stockholders' Equity (2).Retained Earnings 59 . and a realignment of the corporate capital structure to enable the corporation to have a “fresh start” toward financial solvency and profitability.

presents a B/S as of the date of readjustment in which the assets and liabilities are reported at their market values.) The adjustment procedures are: 1. reports to the stockholders with the restatements proposed and obtains the stockholders’ formal consent.Quasi-Reorganization :(contd.  Stockholders' Equity (2). The Corp.Retained Earnings 60 . The Corp. 2.

Any amount written off is first charged against retained earnings and then against additional paid-in capital. begins its “fresh start” with a zero retained earnings balance.Quasi-Reorganization :(contd. 4.): 3. The Corp.) The adjustment procedures (contd.Retained Earnings 61 .  Stockholders' Equity (2).

A write-down of the assets to their market value. An increase of additional paid-in capital accomplished by a decrease in the parvalue of the capital stock. The elimination of the R/E deficit by a reduction of the additional paid-in capital.Quasi-Reorganization :(contd.)  Specific Accounting procedures are: 1. with the loss debited to R/E. 3.Retained Earnings 62 . Stockholders' Equity (2). 2.

Its Inventories and A/R are overvalued by $8.Example: Quasi-Reorganization :(contd.Retained Earnings 63 . CMG has a deficit of $50. respectively.000. with stockholders and the state's approval.) CMG Corp. Stockholders' Equity (2). are determined to have a combined market value of $92.000 prior to the quasi-reorganization.000 and $4.000.000 rather than the book value of $140.'s property and equip. has authorized a reduction in par value of $6 per share. The board of directors.

) Quasi-Reorganization :(contd. To write down the fixed assets to market value: Retained Earnings 48.000 Accu.000 2.000 Stockholders' Equity (2).000 Accounts Receivable 4.) 1.Retained Earnings 64 .Example:(Contd.000 Inventory 8. depreciation 48. To write down the current assets: Retained earnings 12.

000 Retained Earnings* 110. To reduce the par value of stock Common Stock. $4 Par 60.Retained Earnings 65 .000 (the deficit) +48.000 Common Stock.000+12.) 3.000 * 50.) Quasi-Reorganization :(contd.000 Stockholders' Equity (2).000 Additional Paid-in Capital 90. To eliminate the R/E Deficit: Additional Paid-in Capital 110. $10 par 150.000 4.Example:(Contd.

000) 170.000 150.000 equity $ 40.000) in capital Retained earnings Deficit) Total liabilities and stockholders' Total assets $ 170.000 (50.000 $10 par Less: Accumulated Additional paid depreciation (60. 20x5 Current assets $ 30.000 30.Condensed B/S of CMG Corp.000 Liabilities $ Common stock. Property and equipment 200.000 66 Stockholders' Equity (2). before the quasi-reorganization:  CMG Corporation Balance Sheet December 31.Retained Earnings .

000 Liabilities Common stock.Retained Earnings . 20x5 Current assets Property and equipment Less: Accumulated depreciation $ 18.000 Total assets $ Additional paid (108.Condensed B/S of CMG Corp. immediately after the quasi-reorganization:  CMG Corporation Balance Sheet December 31.000 60.000 67 Stockholders' Equity (2).000 equity $ 10.000 $4 par $ 40.000 0 110.000) in capital Retained earnings (see note) Total liabilities and stockholders' 110. 200.

000 was charged against additional paid-in capital.Condensed B/S of CMG Corp.Retained Earnings 68 . immediately after the quasireorganization:(Contd.) Note: Retained earnings as of December 31. and the par value of common stock was reduced from $10 to $4 per share. 20x5 has a zero balance due to a quasi-reorganization on that date in which net assets were revalued. a deficit of $110. Stockholders' Equity (2).

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