Chapter 13-Corporations Effects On Retained Earnings and The Income Statement

Chapter 13
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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Account for stock dividends
Account for stock splits
Account for treasury stock
Report restrictions on retained earnings
Complete a corporate income statement
including earnings per share
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1
Account for stock dividends
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A distribution of a corporation’s own stock
Affects only stockholders’ equity accounts
No effect on total stockholders’ equity
No effect on assets or liabilities
Stockholders receive proportionate shares
Example–10% stock dividend; every stockholder
receives 10% of shares distributed
Total number of shares issued and outstanding increases
Ownership percentages remain the same
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Conserve cash
Continue dividends without using cash
Reduce market price per share
Share supply increases; market price decreases
Less expensive; more attractive investment
Reward investors
Shareholders receive something of value
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Same three dates for a stock dividend
Declaration date; record date; distribution date
Small stock dividend
Distribution is less than 20 to 25% of issued shares
Debit Retained earnings for market value of shares to be
distributed
Credit Common stock for the par value of the stock and
Credit Paid-in capital for excess of par—common
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Large
Distribution is greater than 20% to 25% of issued shares
Debit Retained earnings for par or stated value of shares
Credit Common stock for par or stated value of shares
Rare
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Equity after 5% Common Stock Dividend
Equity after 50% Common Stock Dividend
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Compare and contrast the accounting for cash dividends and stock
dividends.
1.In the space provided, insert either “Cash
dividends,” “Stock dividends,” or “Both cash
dividends and stock dividends” to complete each of
the following statements:
Both cash dividends

a. ________________decrease
and stock dividends Retained earnings.
Stock dividends
b. ________________ has(have) no effect on a
liability.
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(Continued)
Stock dividends
c. ________________ increase Paid-in capital by the
same amount that they decrease Retained earnings.
Cash dividends
d. ________________ decrease both total assets and
total stockholders’ equity, resulting in a decrease in the
size of the company.
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Yummy, Inc., had 310,000 shares of $1 par common stock issued
and outstanding as of December 1, 2012. The company is
authorized to issue 1,400,000 common shares. On December 15,
2012, Yummy declared and distributed a 5% stock dividend when
the market value for Yummy’s common stock was $3.
Requirements:
1. Journalize the stock dividend.
2. How many shares of common stock are outstanding
after the dividend?
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1. Journalize the stock dividend.
Journal Entry
DATE ACCOUNTS DEBIT CREDIT
Dec 15 Retained earnings 46,500
Common stock 15,500
Paid in capital in excess of par- 31,000
common
2. How many shares of common stock are outstanding
after the dividend?
310,000 +15,500 = 325,500
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2
Account for stock splits
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A stock split:
Cuts par value per share
Increases the number of shares of stock issued and
outstanding
Leaves all account balances and total stockholders’
equity unchanged
Balances in the accounts are unchanged
Record in a memorandum entry–a journal entry
without debits and credits
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Before split
After split
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Stock dividends and stock splits have similarities and
differences
Paid-in Total
Common Retained
Event capital in stockholders
stock earnings
excess of par ’ equity
Cash
No effect No effect Decrease Decrease
dividend
Stock
Increase Increase Decrease No effect
dividend
Stock split No effect No effect No effect No effect
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Decorator Plus Imports recently reported the following
stockholders’ equity (adapted except par value per share):
Suppose Decorator Plus split its common stock 2 for 1 in order to

decrease the market price per share of its stock. The company’s
stock was trading at $20 per share immediately before the split.
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1. Prepare the stockholders’ equity section of Decorator
Plus Imports’ balance sheet after the stock split.
Paid-in capital:
Common stock, $0.50 par, 960,000,000 shares
authorized, 228,000,000 shares issued $ 114,000,000
Paid-in capital in excess of par 140,000,000
Total paid-in capital $ 254,000,000
Retained earnings 650,000,000
Total stockholders’ equity $ 904,000,000
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2. Were the account balances changed or unchanged after
the stock split?
Paid-in capital:
Common stock, $0.50 par, 960,000,000 shares
authorized, 228,000,000 shares issued Unchanged $ 114,000,000
Paid-in capital in excess of par Unchanged 140,000,000
Total paid-in capital $ 254,000,000
Retained earnings Unchanged 650,000,000
Total stockholders’ equity Unchanged $ 904,000,000
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3
Account for treasury stock
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Shares that a company has issued and later
reacquired
Reasons corporations purchase their own stock:
To increase net assets by buying low and selling
high
To support the company’s stock price
To avoid a takeover by an outside party
To reward valued employees with stock
A common practice among corporations
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Contra equity account
Debit balance
Recorded at cost (not par)
Reported beneath Retained earnings on the
balance sheet
Reduction to total stockholders’ equity
Decreases outstanding shares
Not eligible for dividends
Not eligible to vote
Issued stock – Treasury stock = Outstanding stock
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Purchase of treasury stock
Company debits Treasury stock and credits Cash
Sale of treasury stock at cost
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Sale of treasury stock above cost
Difference is credited to Paid-in capital from
treasury stock transactions
Sale of treasury stock below cost

Difference is debited to Paid-in Capital from
treasury stock transactions, if available
Otherwise debit Retained earnings
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Sale of treasury stock below cost
Paid-in capital from treasury stock transactions is
insufficient to cover shortfall
Debit Retained earnings for the difference
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Reported beneath Retained earnings as a
reduction
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Discount Center Furniture, Inc., completed the following treasury
stock transactions:
a.Purchased 1,400 shares of the company’s $1 par common stock as
treasury stock, paying cash of $5 per share.
b.Sold 400 shares of the treasury stock for cash of $8 per share.
Requirements
Journalize these transactions. Explanations are not required.
Show how Discount Center will report treasury stock on its

December 31, 2012 balance sheet after completing the two
transactions. In reporting the treasury stock, report only on the
Treasury stock account.
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1. Journalize these transactions. Explanations are not required.
Journal Entry
a. Treasury stock 7,000
Common stock 7,000
Journal Entry
b. Cash 3,200
Treasury stock 2,000
Paid-in capital from treasury
1,200
stock transaction
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2. Show how Discount Center will report treasury stock on its
December 31, 2012 balance sheet after completing the two
transactions. In reporting the treasury stock, report only on the
Treasury stock account.
Stockholders’ equity
Treasury stock 1,000 shares at cost 5,000
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4
Report restrictions on retained earnings
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Restrictions
Requirement by lenders to maintain a minimum level of
equity by limiting:
Cash dividend payments
Treasury stock purchases
Reported in the notes to the financial statements
Appropriations
Restrictions on retained earnings recorded by formal journal
entries
Board of directors may designate purpose of appropriation
Segregate in a separate account
A portion of retained earnings for a specific use
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The heading Paid-in capital does not appear
All additional paid-in capital accounts are combined
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5
Complete a corporate income statement
including earnings per share
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More complex with unique items
Public corporations must publish financial
statements
Sections
Continuing Operations
Special Items
Earnings Per Share
Details important to investors
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Continuing Operations
Should continue from period to period
Useful for making projections about future earnings
Unique items
Gain on sales of machinery–other
Not core to the business
Income tax expense
Subtracted to arrive at income from continuing operations
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Reported after income from continuing
operations
Two distinctly different gains and losses:
Discontinued operations
Extraordinary items
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Segment of a business that has been sold
Each segment is an identifiable division of company
Reported separately because the segment will
not be around in the future
Shown net of tax
Gain - income tax expense = Gain, net of tax
Loss - income tax savings = Loss, net of tax
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Extraordinary gains and losses
Both unusual and infrequent
Not expected to recur in the foreseeable future
Examples:
Losses from natural disasters
Foreign government takeover (expropriation)
Reported net of income tax effect
Items not qualifying as extraordinary
Gains and losses on the sale of plant assets
Losses due to lawsuits
Losses due to employee labor strikes
Natural disasters that occur frequently in the area
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Most widely used business statistic
Measures amount of net income for each share of
common stock outstanding
Issued stock – treasury stock = outstanding shares
Key measure of success in business
Separate EPS figure for each element of income
Income from continuing operations
Income from discontinued operations
Income before extraordinary item
Extraordinary gain or loss
Net income
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Calculation
Preferred dividends also affect EPS
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Preferred dividends must be subtracted from
income to compute EPS
Preferred dividends are paid first
Common will get what is left
* Assume the annual preferred dividend would be $10,000

(10,000 shares X $1.00 dividend per share)
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Altar, Corp., earned net income of $118,000 for 2012. Altar’s books
include the following figures:
Preferred stock, 3%, $50 par, 1,000 shares

issued and outstanding . . . . . . . . . . . . . . . . . . . . . $ 50,000
Common stock, $2 par, 53,000 issued . . . . . . . . . . 106,000
Paid-in capital in excess of par—common . . . . . . 460,000
Treasury stock, common, 1,200 at cost . . . . . . . . . . 24,000
Compute Altar’s EPS for the year.
$(118,000 – 15,000)/51,800 = $2.25*

42 (2.249034749034749) rounded
Reports how retained earnings changed over the
accounting period
Corporate dividends appear where drawings

would appear in proprietorships or partnerships
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Income
Statement
Statement
of
retained
earnings
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Corrections for errors of an earlier period
Due to the closing of accounts, the error is held in Retained
earnings
Correction called prior-period adjustment
Correcting entry includes:
Debit or credit to Retained earnings for error amount
Debit or credit to asset or liability account that was misstated
Reported on statement of retained earnings
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Change in total stockholders’ equity from all sources
other than from its owners
Net income plus or minus:
Unrealized gains/losses on certain investments
Foreign currency translation adjustments*
Gains (losses) from post-retirement benefit plans*
Deferred gains (losses) from derivatives*
*The calculation of these items will be explained in future accounting courses.

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Stock dividends are either small (less than 20%–
25%) or large (greater than 20%–25%). Small
stock dividends are valued at the stock’s fair
market value. Large stock dividends are valued
at par. Stock dividends have no effect on total
stockholders’ equity, but do increase paid-in
capital and decrease Retained earnings.
Stock splits reduce par value and market value
per share. Stock splits increase the number of
issued and outstanding shares. Stock splits have
no effect on any general ledger accounts.
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Treasury stock occurs when a company repurchases
previously issued shares. Treasury stock is a contra
equity account; therefore, increases in Treasury stock
decrease total stockholders’ equity. Treasury stock
purchases are recorded at cost, not par. All gains/losses
on treasury stock sales are reported in the stockholders’
equity accounts.
Restrictions on retained earnings most often arise from
loan restrictions. These restrictions usually require
companies to maintain minimum levels of retained
earnings, thereby restricting amounts available for cash
dividends and treasury stock purchases. Restrictions
must be disclosed in the footnotes to the financial
statements.
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The corporate income statement extends its
coverage to include items that aren’t continuing.
Extraordinary items—those infrequent and
unusual—are reported separately, net of their tax
effect on the income statement. Earnings per
outstanding common share are reported for each
major income statement item. The statement of
retained earnings may include prior-period
adjustments for corrective items.
Comprehensive income includes the four items
identified that aren’t normally reported on the
income statement.
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Printed in the United States of America.
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Chapter 13-Corporations Effects On Retained Earnings and The Income Statement

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Chapter 13

Equity after 50% Common Stock Dividend

Both cash dividends

Stock split No effect No effect No effect No effect

Suppose Decorator Plus split its common stock 2 for 1 in order to

Sale of treasury stock at cost

Sale of treasury stock below cost

Show how Discount Center will report treasury stock on its

Preferred dividends also affect EPS

* Assume the annual preferred dividend would be $10,000

Preferred stock, 3%, $50 par, 1,000 shares

Compute Altar’s EPS for the year.

$(118,000 – 15,000)/51,800 = $2.25*

Corporate dividends appear where drawings

*The calculation of these items will be explained in future accounting courses.

All rights reserved. No part of this publication may be reproduced,

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