• Chapter 12

Income and Changes in Retained Earnings

OUTLINE

Reporting Results of Operation

Financial Analysis (EPS-DILUTED EPS)

Others factor affecting Retained Earnings

11- 1
 RESULT OF

OPERATION
•Continued Operation
•Discontinued operation
•Extraordinary items

11- 2
Reporting the Results of Operations

Information about net income can be

divided into two major categories

Income
Income from
from
continuing
continuing
operations.
operations.

12-3
 This tax expense does not include
effects of unusual, nonrecurring items.

These unusual, nonrecurring items

are each reported net of taxes.
12-4
Discontinued Operations
When management enters into a formal plan to
sell or discontinue a segment of the business, the
related gains and losses must be disclosed on the
income statement.

Discontinued
Operations

12-5
Discontinued Operations

When management enters into a formal plan to

sell or discontinue a segment of the business,
the related gains and losses must be disclosed
on the income statement.

A segment must be a separate line

of business activity or an
operation that services a distinct
category of customers.

12-6
Discontinued Operations
During 2011, Matrix, Inc. sold an
unprofitable segment of the company. The
segment had a net loss from operations
during the period of $150,000 and a loss on
the sale of its assets of $100,000. Matrix
reported income from continuing
operations of $1,750,000. All items are
taxed at 30%.
How will this appear on the income
statement?

12-7
Discontinued Operations

Loss on segment operations $ (150,000)

Less: Tax benefits ($150,000 × 30%) 45,000
Net loss $ (105,000)

Loss on disposal of assets $ (100,000)

Less: Tax benefits ($100,000 × 30%) 30,000
Net loss $ (70,000)

12-8
Discontinued Operations
Income Statement Presentation:
Income from continuing operations $ 1,750,000
Discontinued operations:
Loss on operations (net of
tax benefit of $45,000) (105,000)
Loss on disposal of assets (net
of tax benefits of $30,000) (70,000)
Earnings before extraordinary item $ 1,575,000

12-9
Extraordinary Items
•Material in amount.
•Gains or losses that are both unusual in nature
and not expected to recur in the foreseeable
future.
•Reported net of related taxes.

12-10
Extraordinary Items

During
During 2011,
2011, Matrix,
Matrix, Inc.
Inc. experienced
experienced aa loss
loss
of
of $75,000
$75,000 due
due toto an
an earthquake
earthquake at at one
one of
of its
its
manufacturing
manufacturing plants
plants in
in Chicago.
Chicago. This This was
was
considered
considered anan extraordinary
extraordinary item.
item. The
The
company
company reported
reported income
income before
before
extraordinary
extraordinary item
item ofof $1,575,000.
$1,575,000. All All gains
gains
and
and losses
losses are
are subject
subject toto aa 30%
30% tax
tax rate.
rate.
How
How would
would this
this item
item appear
appear on on the
the 2011
2011
income
income statement?
statement?

12-11
Extraordinary Items

Income Statement Presentation:

Earnings before extraordinary item $ 1,575,000

Extraordinary Loss:
Earthquake loss
(net of tax benefit of $22,500) (52,500)
Net income $ 1,522,500

12-12
 FINANCIA
L
ANALYSIS
•Earnings Per Share

11- 13
Earnings Per Share (EPS)
A measure of the company’s profitability and
earning power for the period.

Earnings Net Weighted Average Number

= ÷
Per Share Income of Shares Outstanding

Based
Based on
on the
the number
number ofof shares
shares
issued
issued and
and the
the length
length of
of time
time
that
that number
number remained
remained
unchanged.
unchanged.
12-14
Earnings Per Share (EPS)

Remember that Matrix, Inc. has income from

continuing operations of $1,750,000. The
after-tax loss from discontinued operations
was $175,000 and the extraordinary loss was
$52,500. Assume that Matrix has 156,250
weighted average shares outstanding.

Let’s prepare a partial income statement

using all this information.

12-15
Earnings Per Share (EPS)

$1,750,000 ÷ 156,250

* Rounded. 12-16
Earnings Per Share (EPS)
If preferred stock is present, subtract preferred
dividends from net income prior to computing EPS.

EPS is required to be
reported in the income
statement.
12-17
Other Transactions affecting
Retained Earnings

•Dividends
•Prior period adjustments
•Comprehensive income

11- 18
Types of Dividends

Cash Dividend
Stock Dividend
• 4 dates that are involved in dividends
distribution
1. Date of Declaration

2. Ex-dividend Date

3. Date of Record

4. Date of Payment

• Entries are made on : declaration date and on

payment date.

11- 19
Dividend Dates

11- 20
Cash Dividends

Declared by Board Not legally

of Directors. required.

Requires sufficient
Creates liability
Retained Earnings
at declaration.
and Cash.
12-21
Dividend Dates
Date of Declaration
• Board of Directors declares the dividend.
• Record a liability.

On March 1, 2011, the Board of Directors of Matrix,

Inc. declares a $1.00 per share cash dividend on its
500,000 common shares outstanding. The dividend is
payable to stockholders of record on April 1, and
paid on May 1.

12-22
Dividend Dates
Ex-Dividend Date
• The day which serves as the ownership cut-off point for the receipt of the
most recently declared dividend.

NO ENTRY

12-23
Dividend Dates

Date of Record
• Stockholders holding shares on this date will
receive the dividend. (No entry)

April 2011

12-24
Dividend Dates

Date of Payment
• Record the payment of the dividend to
stockholders.

12-25
Dividend Dates

On June 1, 2011, a corporation’s board of

directors declared a dividend for the 2,500
shares of its $100 par value, 8% preferred
stock. The dividend will be paid on July 15.
Which of the following will be included in the
July 15 entry?
a. Debit Retained Earnings $20,000.
b. Debit Dividends Payable $20,000.
c. Credit Dividends Payable $20,000.
d. Credit Preferred Stock $20,000.
12-26
Dividend Dates
$100 × 8% = $8 dividend per share
$8 × 1,
On June 2,500 = $20,000
2011, total dividend
a corporation’s board of
directors declared a dividend for the 2,500
shares of its $100 par value, 8% preferred
stock. The dividend will be paid on July 15.
Which of the following will be included in the
July 15 entry?
a. Debit Retained Earnings $20,000.
b. Debit Dividends Payable $20,000.
c. Credit Dividends Payable $20,000.
d. Credit Preferred Stock $20,000.
12-27
Stock Dividends

Distribution of additional shares of

stock to stockholders in proportion to
their present holdings.
No change in total No change in par
stockholders’ equity. values.

All stockholders retain

same percentage
ownership.
12-28
Stock Dividends

• Stock Dividends • Issuance of more-shares dividend (no cash flow is

involved) • Small stock dividends involve issues of less than 20% -
25% of outstanding stock • The accounting for small stock dividends
is based on the fair market value of stock issued. • The accounting for
large stock dividends (more than 20%-25% of outstanding stock) is
based on the par value of stock issued.

11- 29
Entries to Record
Stock Dividends
In accounting for a small stock dividend (less than
20%), the market value of the new shares is
transferred from Retained Earning account to the
paid-in capital accounts. This process is sometimes
called “capitalizing” retained earnings.

On June 1, Aspen Corporation has outstanding

1,000,000 shares of $1 par value common stock with a
market value of $25 per share. The company declares
a 5% stock dividend on this date. The dividend is
distributable on July 15 to stockholders of record on
June 20. Let’s look at the journal entries.
12-30
Entries to Record small
Stock Dividends

Common shares outstainding 1,000,000

Stock dividend percent 5%
Additional shares issuable 50,000
Market value per share $ 25
Amount assigned to dividend $ 1,250,000

Additional shares issuable 50,000

Par value per share $ 1
Change in common stock account $ 50,000

12-31
Dividend Dates
Date of Declaration
• Board of Directors declares the dividend.
• Do not record a liability.

Date Description Debit Credit

Jun. 1 Retained Earnings 1,250,000
Stock Dividend to be Distributed 50,000
Additional Paid-in Capital: Stock Dividend 1,200,000

50,000 shares × $1 par value

12-32
Dividend Dates
Ex-Dividend Date
• The day which serves as the ownership cut-off point for the receipt of the
most recently declared dividend.

NO ENTRY

12-33
Dividend Dates

Date of Record
• Stockholders holding shares on this date will
receive the dividend. (No entry)

June 2011

12-34
Dividend Dates

Date of Payment
• Record the payment of the dividend to
stockholders.

Date Description Debit Credit

Jul. 15 Stock Dividend to be Distributed 50,000
Common Stock 50,000

12-35
Large Stock Dividends 

• Outstanding stock: 3,000 shares; $10 par

• Stock dividend: 30%
• FMV on date of declaration: $12
Distribution Large Stock Dividends Stock dividend = 30% of 3,000 shares =
900 shares
Declaration Date
• Dr. Ret. Earnings 9,000  
• Cr. CS Distributable 9,000
Distribution Date
• Dr. CS Distributable 9,000
• Cr. Common Stock 9,000

11- 36
Reasons for Stock Dividends
Management often finds stock dividends
appealing because they allow management to
distribute something of perceived value to
stockholders while conserving cash which may
be needed for other purposes.

Stockholders like stock dividends because they

receive more shares, often the stock price does
not fall proportionately, and the dividend is not
subject to income taxes (until the shares
received are sold).
12-37
Distinction between Stock Splits and
Stock Dividends
The difference between a stock dividend and a
stock split lies in the intent of management and
the related issue of the size of the distribution. A
stock dividend usually is intended to substitute
for a cash dividend and is small enough that the
market price of the stock is relatively unaffected.

Stock dividends do not result in a change in the

par value of the stock. On the other hand, stock
splits result in a pro rata reduction in the par
value of the stock.

12-38
Stock Dividend Vs Stock Split

• Stock Dividend
Par value of a share does not change, Total number of shares
increases,Total stockholders’ equity does not change The
composition of equity changes (less of retained earnings;
more of stock) Stock dividends require journal entries.
• Stock Split
Par value of a share decreases,Total number of shares
increases,Total stockholders’ equity does not change The
composition of equity does not change (same amounts of
stock and RE) Stock splits do not require journal entries.

11- 39
Summary of Effects of Stock
Dividends and Stock Splits
Small
SmallStock
Stock Large
LargeStock
Stock Stock
StockSplits
Splits
Dividend
Dividend Dividend
Dividend
Total
Total
Stockholders'
Stockholders' No
NoEffect
Effect No
NoEffect
Effect No
NoEffect
Effect
Equity
Equity
Common
CommonStock
Stock Increases
Increases Increases
Increases No
NoEffect
Effect
Paid-in
Paid-inCapital
Capital Increases
Increases No
NoEffect
Effect No
NoEffect
Effect
Retained
RetainedEarnings
Earnings Decreases
Decreases Decreases
Decreases No
NoEffect
Effect
Number
Numberof ofShares
Shares Increases
Increases Increases
Increases Increases
Increases
Outstanding
Outstanding
Par
ParValue
Valueper
per No
NoEffect
Effect No
NoEffect
Effect Decreases
Decreases
Share
Share
12-40
Cash Vs. Stock Dividend

•
Cash Dividends Stock Dividends
• Reduce assets & equity •No assets are
distributed
• Distribution of cash • % of ownership still the same

11- 41
Statement of Retained
Earnings with Prior Period
Adjustment

12-42
Prior Period Adjustments

The correction of an error identified as

affecting net income in a prior period.

Adjust retained The adjustment

earnings should be
retroactively. disclosed net of
any taxes.

12-43
Statement of Retained
Earnings with Prior Period
Adjustment

12-44
Restrictions of Retained Earnings
If I loan your company $1,000,000,
I will want you to restrict your
retained earnings in order to limit
dividend payments.

Loan agreements can include restrictions

on paying dividends below a certain
amount of retained earnings.
12-45
Comprehensive Income

Normally, there are 3 ways that

financial position can change.

Issuance
Issuance of
of Net
Net Income
Income or
or Payment
Payment of
of
new
new shares
shares of
of Net
Net Loss
Loss Dividends
Dividends
stock.
stock.

FASB excludes
some unrealized items from income, such as the
change in market value of available-for-sale debt
and equity investments.

12-46
Comprehensive Income
FASB requires that unrealized items that are normally
reported on the balance sheet be added back to
compute “Comprehensive Income.”

12-47
Statement of Stockholders’ Equity

This is a more inclusive statement than

the statement of retained earnings.
12-48
Stockholders’ Equity Section of the
Balance Sheet

12-49