on Retained Earnings and the Income Statement Chapter 13 1 Learning Objectives 2 Account for stock dividends Account for stock splits Account for treasury stock Report restrictions on retained earnings ID: 156445
Download Presentation The PPT/PDF document "Corporations: Effects" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1
Corporations: Effects on Retained Earnings and the Income Statement
Chapter 13
1Slide2
Learning Objectives
2
Account for stock dividends
Account for stock splits
Account for treasury stock
Report restrictions on retained earnings
Complete a corporate income statementincluding earnings per shareSlide3
Account for stock dividends
3
1Slide4
Dividend variations
Cash dividendsActual money goes out to share holders.
This is real money. Shareholders can spend it.
Stock dividends
This is not money. No money is sent to anybody.
The company sends additional shares of stock to every owner, proportional to their shares held.
Every owner maintains the exact same percentage ownership in the company.Question: Which does not involve the cash account?Slide5
Stock Dividend
A distribution of a corporation’s own stockAffects only stockholders’ equity accounts
No effect on total stockholders’ equityNo effect on assets or liabilitiesStockholders receive proportionate sharesExample–10% stock dividend; every stockholder receives 10% more shares
If you own 100 shares, you get 10 more
If I own 10 shares, I get 1 more
Total number of shares issued and outstanding increases
Ownership percentages remain the same5Slide6
Why Do Companies Issue Stock Dividends?
Conserve cashContinue dividends without using cash
Reduce market price per share
6
Share supply increases; market price decreases
Less expensive; more attractive investment
Reward investorsShareholders receive something of perceived valueIf I just got more shares, and everyone else got more shares too, are any of us really better off?Slide7
The point of this transaction is to put the retained earnings more visibly “in the hands” of the investor.
A small stock dividend shouldn’t materially affect the stock price, so we do the transaction at market price.
Take the market value of the new shares out of retained earnings {Debit Retained earnings}
Put that amount into Common stock account subject to that accounts
par value limits
{Credit Capital stock} {Or, Credit: Stock dividend to be distributed}3) Put the residual in the Additional paid In capital account {Credit: Additional paid in capital}Small Stock Dividend Logic PathSlide8
Entries for Small Stock Dividend
Same three dates for a stock dividend
Declaration date; record date; distribution dateWe are preparing one single summary transactionPull full market value from retained earnings
Put it in the common stock account, subject to par
Demo: Issue a 5% stock dividend on common stock
There are 2,000,000 shares of $1 par stock outstanding
The stock is trading at $50 (market value)What did we just do to the usefulness of the balance sheet? 8Slide9
Large stock dividends
These are greater than 25%, large enough to affect stock price.So, there is no pretending that they won’t.Since we aren’t pretending to support market price, we just take the par value out of retained earnings and reposition that as common stock
This keeps the stock price affordable to smaller investors and placates investor return desires.
9Slide10
Entries for Large Stock Dividend
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
RareJournal entry demo: 50% stock dividend2,100,000 shares outstanding$1 par valueThese are quite rare, normally a company will either do a small stock dividend, or a stock split. 10Slide11
Stockholders’ Equity Presentation
Equity after 5% Common Stock Dividend
Equity after 50%
Common Stock Dividend
11Slide12
S13-2: Comparing and contrasting cash and
stock dividends
Compare and contrast the accounting for cash dividends and stock dividends.
In the space provided, insert either “Cash dividends,” “Stock dividends,” or “Both cash dividends and stock dividends” to complete each of the following statements:
a.
________________
decrease Retained earnings.b. ________________ has(have) no effect on a liability.12Both cash dividends and stock dividendsStock dividendsSlide13
S13-2:
Comparing and contrasting cash and stock dividends
(Continued)
c.
________________
increase Paid-in capital by the same amount that they decrease Retained earnings.
d. ________________ decrease both total assets and total stockholders’ equity, resulting in a decrease in the size of the company.13Stock dividendsCash dividendsSlide14
S13-3: Accounting for a stock dividend
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?
14Slide15
S13-3: Accounting for a stock dividend
Journalize the stock dividend
.
2. How many shares of common stock are outstanding after the dividend?
15
Journal Entry
DATEACCOUNTSDEBITCREDITDec 15Retained earnings
46,500
Common stock
15,500
Paid in capital in excess of par-common
31,000
310,000 +15,500 = 325,500Slide16
Account for stock splits
16
2Slide17
Which is a better deal?
2 big slices at $4 each?
4 little slices at $2 each?Slide18
Casual investor perceptions
$100 stocks seem too expensive
$50 stocks must be doing well
$0.50 stocks must be underperforming companies
Stock splits can be performed to put the per share price wherever you want it.Slide19
Why is there price movement around stock splits?
Small investors view the stock as more affordable.
Sustainable stock price increase indicator. To the extent that people agree that the price will move, this belief alone may cause the move – especially if it is helped along a little…...
2-for-1.com
GE, MSFT, HOG, AAPL, HD
Stock Split Market Price Effects
http://www.stocksplits.net/Slide20
Stock Splits
A stock split:Cuts par value per shareIncreases the number of shares of stock issued and outstanding
Leaves all account balances and total stockholders’ equity unchangedBalances in the accounts are unchangedRecord in a memorandum entry–a journal entry without debits and credits
20Slide21
Stock Split Balance Sheet Effects
Old Balance Sheet item:
Common Stock, $1 par value, 3,150,000
Shares issued and outstanding....................$3,150,000
NEW Balance Sheet item:
Common Stock, 50
¢ par value, 6,300,000shares issued and outstanding……………...$3,150,000Slide22
Stock Split Mechanics
Assume a company had 10,000 shares outstanding trading at $100 per share.
How would different splits effect the number of shares outstanding and the stock price?Normal stock split: 2 for 1
Reverse stock split: 1 for 2Slide23
Stock Split Example
Before split
23
After splitSlide24
Effects of Dividends and Stock Splits
Stock dividends and stock splits have similarities and differences
24
Event
Common
stock
Paid-in capital in excess of parRetained earningsTotal stockholders’ equityCash dividendNo effectNo effect
Decrease
Decrease
Stock dividend
Increase
Increase
Decrease
No effect
Stock split
No effect
No effect
No effect
No effectSlide25
S13-5:
Accounting for a stock split
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.
25Slide26
S13-5:
Accounting for a stock split
1. Prepare the stockholders’ equity section of Decorator Plus Imports’ balance sheet after the stock split.
26
Paid-in capital:
Common stock, $0.50 par, 960,000,000 shares
authorized, 228,000,000 shares issued$ 114,000,000Paid-in capital in excess of par140,000,000Total paid-in capital
$ 254,000,000
Retained earnings
650,000,000
Total stockholders’ equity
$ 904,000,000Slide27
S13-5:
Accounting for a stock split
2. Were the account balances changed or unchanged after the stock split?
27
Paid-in capital:
Common stock, $0.50 par, 960,000,000 shares
authorized, 228,000,000 shares issued$ 114,000,000Paid-in capital in excess of par140,000,000Total paid-in capital
$ 254,000,000
Retained earnings
650,000,000
Total stockholders’ equity
$ 904,000,000
Unchanged
Unchanged
Unchanged
UnchangedSlide28
Account for treasury stock
28
3Slide29
Treasury Stock
Shares that a company has issued and later reacquiredHeld as a contra equity account at repurchase cost
No entry made to original capital stock accountReasons corporations purchase their own stock:Buy low and sell high to increase wealthTo boost the company’s stock price
To avoid a takeover by an outside party
To make stock available for employee rewards
An alternate way to give cash to shareholders
29Slide30
The maximum number of shares of capital stock that may be sold to the public.
Authorized
Shares
Where Treasury Stock Comes FromSlide31
Issued shares
are authorized shares of stock that have been sold.
Unissued shares
are authorized shares of stock that never have been sold.
Authorized
Shares
Where Treasury Stock Comes FromSlide32
Unissued
Shares
Treasury
Shares
Outstanding
Shares
Treasury shares are issued shares that have been repurchased by the corporation.IssuedSharesOutstanding shares are issued shares that are currently owned by stockholders.AuthorizedShares
Where Treasury Stock Comes From
NO voting rights!
No dividends!Slide33
Unissued
Shares
Outstanding
Shares
Issued
Shares
Outstanding shares are issued shares that are currently owned by stockholders.AuthorizedSharesWhere Treasury Stock Comes FromWhen treasury stock is re-issued it becomes regular stock again!Slide34
It’s a good value!
Stimulate Demand for stock
Why have treasury stock?
Employee Rewards
Increase Earnings per shareSlide35
Accounting for Treasury Stock
Contra equity accountDebit balanceRecorded at cost (not par)
Reported beneath Retained earnings on the balance sheetReduction to total stockholders’ equityDecreases outstanding sharesNot eligible for dividends
Not eligible to vote
35
Issued stock – Treasury stock = Outstanding stockSlide36
Treasury Stock Journal Entries
Purchase of treasury stockCompany debits Treasury stock and credits Cash
Sale of treasury stock at cost
Next: Treasury stock earnings bypass the income statement!
36Slide37
Treasury Stock Journal Entries
Sell 200 shares of that $5 cost stock @ $6 eachDifference is credited to Paid-in capital from treasury stock transactions
Sell 200 shares of that $5 treasury stock @ $4.30Difference is debited to Paid-in Capital from treasury stock transactions, if available
Debit Retained earnings if that account is empty
37Slide38
Treasury Stock Journal Entries
Sell 200 shares of that $5 Treasury stock @ $4.50 per share.Paid-in capital from treasury stock transactions is insufficient to cover shortfall
Debit Retained earnings for the difference
38Slide39
Treasury Stock and Stockholders' Equity
Reported beneath Retained earnings as a reduction
39Slide40
S13-6:
Accounting for the purchase and sale of treasury stock
Discount Center Furniture, Inc., completed the following treasury stock transactions:Purchased
1,400 shares of the company’s $1 par common stock as
treasury stock
, paying cash of $5 per share
. Sold 400 shares of the treasury stock for cash of $8 per share.RequirementsJournalize 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. 40Slide41
S13-6:
Accounting for the purchase and sale of treasury stock
Journalize these transactions. Explanations are not required.
41
Journal EntryDATEACCOUNTSDEBITCREDITa.Treasury stock
7,000
Common stock
7,000
Journal Entry
DATE
ACCOUNTS
DEBIT
CREDIT
b.
Cash
3,200
Treasury stock
2,000
Paid-in capital from treasury
stock transaction
1,200Slide42
S13-6:
Accounting for the purchase and sale of treasury stock
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.
42
Stockholders’ equity
Treasury stock 1,000 shares at cost
5,000Slide43
Report restrictions on retained earnings
43
4Slide44
Restrictions on Retained Earnings
RestrictionsRequirement 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 entriesBoard of directors may designate purpose of appropriationSegregate in a separate accountA portion of retained earnings for a specific use 44Slide45
Stockholders’ Equity with Appropriations
The heading Paid-in capital does not appearAll additional paid-in capital accounts are combined
45Slide46
Complete a corporate income statement including earnings per share
46
5Slide47
Reporting the Results of Operations
Information about net income can be divided into two major categories
Income from continuing operations.
1. The results of discontinued operations
2. The impact of extraordinary items.
3. The effects of changes in accounting principles.
Normal, recurring revenue and expense transactions.
Unusual, nonrecurring events that affect net income.Slide48
The Corporate Income Statement
More complex with unique itemsPublic corporations must publish financial statementsSectionsContinuing Operations
Special ItemsEarnings Per ShareDetails important to investors
48Slide49
The Corporate Income Statement
Continuing Operations
Why use this number?This should be the basis of forecasting future year earnings
If you are buying into a company now, this is the basis you care about, not those other non-repeating items.
49
Should continue from period to period
Useful for making projections about future earningsSlide50
Special Items
Reported after income from continuing operationsReported net of any tax effectsTwo distinctly different gains and losses:
Discontinued operationsExtraordinary itemsNote: Plant asset gains/losses are part of continuing operations
50Slide51
Discontinued Operations
Segment of a business that has been soldEach segment is an identifiable division of companyReported separately because the segment will not be around in the future
Operating profits/lossGain/loss on sale of the segment
51Slide52
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.
NOT: lawsuits, strikes, recurring acts of nature, plant asset gains/lossesExtraordinary ItemsSlide53
Extraordinary Items
Both unusual and infrequentNot expected to recur in the foreseeable futureExamples:
Losses from natural disastersForeign government takeover (expropriation)Reported net of income tax effect
Items not
qualifying as extraordinary
Gains and losses on the sale of plant assetsLosses due to lawsuitsLosses due to employee labor strikesNatural disasters that occur frequently in the area53Slide54
During
2011,
an earthquake caused $75,000 damage to Apex’s factory.
The company reported income before extraordinary item of $175,000.
All gains and losses are subject to a 30% tax rate.
How would this item appear on the
2011 income statement?Extraordinary Items - ExampleSlide55
Income Statement Presentation:
Extraordinary Items - Example
Income Statement Presentation:Slide56
Earnings per Share (EPS)
Measures amount of net income for each share of common stock outstanding
Separate EPS figure for different purposesIncome from continuing operationsForward projection: if you are going to buy it
Net income
Historical perspective: if you already own it
56Slide57
Earnings per Share (EPS)
Calculation
Preferred dividends also affect EPS
57Slide58
EPS and Preferred Stock
Preferred dividends must be subtracted from income to compute EPSPreferred 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)58Slide59
E13-20: Computing EPS
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 . . . . . . . . . . . . . . . . . .
. . . $ 50,000Common stock, $2 par, 53,000 issued . . . . . . . . . . 106,000Paid-in capital in excess of par—common . . . . . . 460,000Treasury stock, common, 1,200 at cost . . . . . . . . . . 24,000Compute Altar’s EPS for the year. $(118,000 – 15,000)/51,800 = $2.25*(2.249034749034749) rounded59Slide60
Evaluating Earnings Per Share
Growth rateCompanies aim to increase earnings per share to demonstrate increasing wealth building powerEarnings relative to stock priceComparing the stock price per share to the earnings per share provides a measure of value of the stock
The Price to Earnings ratio compares stock price to earnings per shareA measure of how much it costs to buy $1.00 in a company’s earnings.A high p/e ratio indicates an expensive stock
A low p/e ratio indicates a value stock
60Slide61
Price to Earnings Ratio
P/E ratio = Price per share ÷ Earnings per shareUsing the P/E ratio:Find a company you like based on:Earnings – strong income statement
Balance sheet – strong financial standingCash flows – learn next weekSituation analysisTHEN, evaluate whether or not it is worth the purchase price by using the p/e ratio
61Slide62
Statement of Retained Earnings
Reports how retained earnings changed over the accounting period
Corporate dividends appear where drawings would appear in proprietorships or partnerships
62Slide63
Combined Statement of Income andRetained Earnings
63
Income Statement
Statement
of
retained earningsSlide64
Prior-Period Adjustments
Corrections for errors of an earlier periodDue to the closing of accounts, the error is held in Retained earnings
Correction called prior-period adjustmentCorrecting 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
64Slide65
Reporting Comprehensive Income
Change in total stockholders’ equity from all sources other than from its ownersNet income plus or minus:
Unrealized gains/losses on certain investmentsForeign currency translation adjustments*Gains (losses) from post-retirement benefit plans*Deferred gains (losses) from derivatives*
65
*The calculation of these items will be explained in future accounting courses.Slide66
Chapter 13 Summary
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.
66Slide67
Chapter 13 Summary
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.67Slide68
Chapter 13 Summary
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.
68Slide69
69Slide70
Copyright
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.
70