copyright © 2007 prentice-hall. all rights reserved 1 corporations: retained earnings and the...

Copyright © 2007 Prentice-Hall. All rights reserved 1

Corporations:Corporations:Retained Earnings and the Retained Earnings and the

Income StatementIncome Statement

Corporations:Corporations:Retained Earnings and the Retained Earnings and the

Income StatementIncome StatementChapter 12


Retained EarningsRetained EarningsRetained EarningsRetained Earnings

• All net income minus net losses minus dividends

• Negative balance in Retained Earnings - deficit

• Not a fund of cash


Objective 1Objective 1Objective 1Objective 1

Account for stock dividends


Stock Dividend Stock Dividend Stock Dividend Stock Dividend

• Proportional distribution of corporation’s own stock to shareholders

• Does not change total stockholders’ equity

• Transfer of retained earnings to contributed capital – no assets are distributed


Entries for Stock DividendEntries for Stock DividendEntries for Stock DividendEntries for Stock Dividend

Small • Distribution is < 20-

25% of previously outstanding shares

• Debit retained earnings for market value of shares to be distributed

Large • Distribution is > 25% of

previously outstanding shares

• Debit retained earnings for par or stated value of shares


E12-13E12-13

How many shares of stock are distributed?

50,000 × 10% = 5,000 shares

How much will be debited to retained earnings?

5,000 shares x $14 = $70,000


E12-13E12-13

USE MARKET VALUE5,000 shares x $14

USE PARCommon stock = 5,000 shares x $1

GENERAL JOURNAL

DATE DESCRIPTION REF DEBIT CREDIT

Apr 30 Retained Earnings 70,000Common Stock 5,000Paid in Capital in Excess ofPar, Common 65,000


E12-13E12-13E12-13E12-13

Stockholders’ Equity:

Paid in Capital:

Common stock, $1 par, 100,000 shares authorized, 55,000 shares issued $55,000

Paid in capital in excess of par 265,000Total paid in capital $320,000Retained earnings ($120,000-70,000) 50,000Total stockholders’ equity $370,000

The number of shares issued increased.Retained earnings decreased

Total stockholders’ equity is the same


Stock SplitsStock SplitsStock SplitsStock Splits

• Increases the number of shares authorized, issued and outstanding

• Decreased par value per share

• Balances in the accounts are unchanged

• Record in a memorandum entry


E12-15E12-15

GENERAL JOURNAL


Jun 30 Called in the outstanding $1 par common stock and distributed 2 shares of $0.50 par common stock for each old. There are now 100,000 sharesoutstanding.


E12-3E12-3E12-3E12-3

Stockholders’ Equity:Paid in Capital:

Common stock, $0.50 par, 400,000 shares authorized, 100,000 shares issued $50,000

Paid in capital in excess of par 100,000Total paid in capital $150,000Retained earnings 200,000Total stockholders’ equity $350,000

Par value is cut in half

None of the amounts in the accounts have changed

Shares authorized and issued are double



Distinguish stock splits from stock dividends


Comparison: StockComparison: StockDividends & Stock SplitsDividends & Stock Splits

Comparison: StockComparison: StockDividends & Stock SplitsDividends & Stock Splits

Stock Dividend:• Shifts amounts from

retained earnings to paid-in capital

• Par value per share remains unchanged

• Number of shares issued increases

• Total stockholders’ equity does not change

Stock Split:• Account balances do not

change

• Par value decreases

• Number of shares of stock authorized, issued, and outstanding increase

• Total stockholders’ equity does not change



Account for treasury stock


Treasury StockTreasury StockTreasury StockTreasury Stock

• Shares that a company has issued and later reacquired

• Purchasing treasury stock decreases assets and stockholders’ equity

• Contra equity account

• Record at cost

• Report after retained earnings on balance sheet


E12-17E12-17E12-17E12-17GENERAL JOURNAL


Feb 4 Cash 200,000Common Stock 20,000Paid in Capital in Excess ofPar, Common 180,000

Apr 22 Treasury Stock 14,000Cash 14,000

Contra Equity Account


E12-17E12-17E12-17E12-17GENERAL JOURNAL


Aug 22 Cash 12,000Treasury Stock 8,400Paid in Capital from Treasury Stock Transactions 3,600


E12-17E12-17E12-17E12-17

Common Stock

Paid in CapitalIn Excess of Par,

Common

Paid in Capitalfrom Treasury

Stock Transactions

Retained Earnings Treasury Stock

20,000 180,000

14,000100,000*

*Assumed

8,400

3,600

5,600


*Assumed

Austin Driving School, Inc.Partial Balance SheetDecember 31, 2008

Stockholders’ EquityPaid in Capital:

Common Stock $20,000Paid in Capital in Excess of Par, Common 180,000Paid in Capital from Treasury Stock Transactions 3,600 Total Paid in Capital $203,600

Retained Earnings 100,000 Subtotal $303,600Less Treasury Stock (400 shares at cost) 5,600Total Stockholders’ Equity $298,000


Shares Issued & OutstandingShares Issued & OutstandingShares Issued & OutstandingShares Issued & Outstanding

• Issued shares – number of shares sold

• Outstanding shares – number of shares in the hands of stockholders

• Treasury stock decreases the number of shares outstanding

• Treasury stock does not receive dividends

In the previous example, then, the number of shares issued are 20,000. The number of shares outstanding are 19,600 (20,000 – 400 shares in treasury)


Retirement of StockRetirement of StockRetirement of StockRetirement of Stock

• Decreases outstanding stock

• Retired shares cannot be reissued

• Remove stock from books– Debit stock accounts– Credit cash



Report restrictions on retained earnings


Restrictions on Retained Restrictions on Retained EarningsEarnings

Restrictions on Retained Restrictions on Retained EarningsEarnings

• Reported in notes to financial statements

• Restricts amount of retained earnings available for dividends

• Appropriations are restrictions on retained earnings recorded by formal journal entries


E12-19 aE12-19 aE12-19 aE12-19 a

Stockholders’ equity:

Common stock, no par $50,000

Retained earnings—Note X 250,000

Total stockholders’ equity $300,000

Note X— Long-term debt (or Restriction of retained earnings). The company’s long-term debt agreement restricts retained earnings in the amount of $200,000.


E12-19 b E12-19 b E12-19 b E12-19 b

Stockholders’ equity:

Total paid-in capital $50,000

Retained earnings:

Appropriated for debt agreement $100,000

Unappropriated 150,000

Total retained earnings 250,000

Total stockholders’ equity $300,000



Analyze a corporate income statement


Corporate Income StatementCorporate Income StatementCorporate Income StatementCorporate Income Statement

Continuing Operations Normal operating revenues and expenses, including income tax expense

Special Items

Items that are material in amount, but are not typical of regular operations

Earnings Per Share

Amount of net income for each share of outstanding common stock


Income from Continuing Income from Continuing OperationsOperations

Income from Continuing Income from Continuing OperationsOperations

• Measures profitability of the ongoing operations

• Useful for making projections about future earnings


Special ItemsSpecial ItemsSpecial ItemsSpecial Items

• Reported after income from continuing operations– Discontinued operations– Extraordinary gains and losses


Discontinued OperationsDiscontinued OperationsDiscontinued OperationsDiscontinued Operations

• Segment of a business that has been sold

• Two parts– Income or loss from operations of business

from beginning of year to date of disposal– Gain or loss on disposal of the assets of the

segment– Reported net of the income tax effect


Extraordinary ItemsExtraordinary ItemsExtraordinary ItemsExtraordinary Items

• Both unusual and infrequent– Unusual in nature – abnormal and only

incidentally related to customary activities– Infrequent in occurrence – not reasonably

expected to happen in the foreseeable future

• Reported net of income tax effect


Conner Photographic Supplies, Inc.Income Statement

Year Ended December 31, 2008Sales revenue $430,000Cost of goods sold (240,000) Gross profit $190,000Operating expenses (120,000)Income from continuing operations $70,000Loss on discontinued operations $(50,000) Income tax savings 20,000 (30,000)Income before extraordinary items $40,000Extraordinary loss $(15,000) Income tax savings 6,000 (9,000)Net income $31,000

E12-20E12-20E12-20E12-20


Earnings Per ShareEarnings Per ShareEarnings Per ShareEarnings Per Share

Net income - Preferred dividends Average number of common shares outstanding

Report separate EPS figures for each line on income statement starting with income from continuing operations though to net income


Earnings Per ShareEarnings Per Shareand Preferred Stockand Preferred StockEarnings Per ShareEarnings Per Shareand Preferred Stockand Preferred Stock

Corporations with complex capital structures present two sets of EPS amounts

• Basic EPS

• Diluted EPS


E12-21E12-21E12-21E12-21

$108,000 – (1,000 x 6% x $50)

(52,000 shares – 2,000 shares)

= $105,000 / 50,000 shares

= $2.10

Net income - Preferred dividends Average number of common shares outstanding

Remember: Treasury stock is not considered outstanding


Earnings per share:Income from continuing operations[($110,000 – $5,000) / 50,000] $2.10Loss on discontinued operations ($8,000 / 50,000) (.16)Income before extraordinary items[($102,000 – $5,000) / 50,000] $1.94Extraordinary gain ($20,000 / 50,000) .40Net income [($122,000 – $5,000) / 50,000] $2.34

E12-22E12-22E12-22E12-22Preferred dividends:10,000 $10 .05 = $5,000


Statement of Retained EarningsStatement of Retained Earnings

• Reports how retained earnings changed over the accounting period

• Beginning balance + net income – dividends = Ending balance


Comprehensive IncomeComprehensive IncomeComprehensive IncomeComprehensive Income

• Change in total stockholders’ equity from all sources other than from its owners– Net income – Unrealized gains/losses on certain

investments– Foreign currency translation adjustments


Prior Period AdjustmentsPrior Period AdjustmentsPrior Period AdjustmentsPrior Period Adjustments

• Corrections to beginning balance of Retained Earnings for errors of an earlier period

• 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


E12-24E12-24E12-24E12-24Sarah Lou Bakery, Inc.

Statement of Retained EarningsYear Ended December 31, 2003

MillionsRetained earnings, December 31, 2002,

as originally reported $39,000Prior period adjustment (5,000)Retained earnings, December 31, 2002,

as adjusted 34,000Net income for 2003 70,000 Subtotal 104,000Dividends for 2003 (24,000)Retained earnings, December 31, 2003 $80,000


End of Chapter 12End of Chapter 12End of Chapter 12End of Chapter 12

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