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Net income of a corporation and corporate income taxes

Cash dividends

Stock dividends

Stock splits

Appropriations of retained earnings

Retained Earnings Statement

Chapter 20 Corporate Accounting: Earnings and Distribution

Net Income/Loss of A Corporation

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Net Income AKA net loss The bottom line of the income statement for every

form of business

Income Summary account (after closing revenue and expenses) Credit balance = net income

Debit balance = net loss

For a corporation, the net income or net loss is closed to the Retained Earnings account.

The net income of a corporation is calculated in the same way as that of a proprietorship or a partnership.

Example

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• Assume on Dec. 31, 20X2, Ace Trucking, Inc. reports a net income of $72,500.

• Ace would record the following entry to close net income into the Retained Earnings account:

20X2

Dec. 31 Income Summary 72,500

Retained Earnings 72,500

• Assume on Dec. 31, 20X2 Ace Trucking, Inc. reports a net loss of $40,000.

• Ace would report the following entry to close net loss into the Retained Earnings account:

20X2

Dec. 31 Retained Earnings 40,000

Income Summary 40,000

Corporate Income Tax The corporate income tax rate is a progressive rate; that is, the higher

the income, the higher the tax rate.

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• Assume taxable income is $450,000.

• Corporate income tax would be calculated as following, using the corporate income tax rates:

$ 50,000 × .15 = $ 7,500

25,000 × .25 = 6,250

25,000 × .34 = 8,500

235,000 × .39 = 91,650

115,000 × .34 = 39,100

Total Tax = $153,000

Paying Income Taxes: Corporations

• Pay-as-you-go

• Estimate annual income tax expense

• Make four quarterly payments

• April 15

• June 15

• September 15

• December 15

• Any tax still owed at year-end is accrued on Dec. 31 and must be paid by March 15 of the following year.

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Example: Paying Income Tax

• Assume Ace Trucking estimates income taxes for 20X1 to be $9,000.

• At Dec. 31, 20X1, Ace determines its total income tax for 20X1 to be $10,000.

• Ace records the following journal entries during 20X1 and its final tax payment for 20X1 taxes on Mar. 15, 20X2.

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20X1

Apr. 15 Income Tax Expense 2,250

Cash 2,250

Jun. 15 Income Tax Expense 2,250

Cash 2,250

Sep. 15 Income Tax Expense 2,250

Cash 2,250

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20X1

Dec. 15 Income Tax Expense 2,250

Cash 2,250

Dec. 31 Income Tax Expense 1,000

Income Tax Payable 1,000

20X2

Mar. 15 Income Tax Payable 1,000

Cash 1,000

Example: Paying Income Tax (continued)

Dividends • The distribution of corporate earnings • Investors in corporations buy stock with one basic goal in mind

— to receive a return on their investment • This goal can be accomplished in two ways:

• Stock grows in value, allowing investors to resell the stock for a gain

• Stockholders to receive a share of the corporation’s earnings

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Cas

h D

ivid

end

s • The most common form of dividend

• Before a cash dividend can be declared and paid, three things are needed:

• Sufficient retained earnings above the legal capital requirement of the company

• Sufficient cash above working capital needs

• Formal action by the board of directors

Dates Associated with a Cash Dividend

• Date of Declaration

• The date the board of directors formally declares that a dividend will be paid

• Date of Record

• The date as of which the ownership of shares is established

• Date of Payment

• The date that dividend checks are mailed to stockholders of record

• Many corporations maintain a constant dividend policy. IBM, for example, normally pays dividends on the 10th of March, June, September and December.

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Journal Entries for Cash Dividends • On Jan. 15, 20X1, the board of directors of Hudson Corporation

declares a $2 cash dividend for common stockholders of record on Jan. 31, to be paid on Feb.15.

• Hudson has 10,000 shares of $10 par common stock outstanding. • Journal entries are required on Jan. 15, 20X1 and on Feb. 15,

20X1. • No journal entry is required on Jan. 31, date of record.

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20X1

Jan. 15 Cash Dividends 20,000

Dividends Payable 20,000

Feb. 15 Dividends Payable 20,000

Cash 20,000

Dividends on Cumulative Preferred Stock

Assume Bonner Corporation has outstanding 5,000 shares of $100 par, 10% cumulative preferred stock and 50,000 shares of $5 par common stock.

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• On Jul. 2, 20X1, Hudson Corporation declares a 10% common stock dividend to common stockholders of record as of Aug. 10, to be distributed on Sep. 1.

• Hudson has 10,000 shares of $10 par common stock outstanding. Hudson’s common stock is current selling for $18 per share. Journal entries are required on Jul. 2, 20X1, and on Sep. 1, 20X1.

Stock Dividends

• A proportional distribution of additional shares of a company’s own authorized stock to its stockholders.

• Distributed on a pro rata basis • Additional shares of stock are issued in proportion to the

number of shares owned by each present stockholder. • For example, if a corporation declares a 10% stock dividend

and an investor currently owns 100 shares, the investor would receive an additional 10 shares of stock.

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Example

Example: Stock Dividends

• No journal entry is required on Aug. 10, date of record. • On date of declaration, the Stock Dividends account is debited for

the new shares issued times the current selling price of the stock. • The Common Stock Dividends Distributable account is credited for

the par value of the new shares issued. • Paid-in Capital in Excess of Par Value-Common is credited for the

difference.

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20X1

Jul. 2 Stock Dividends 18,000

Common Stock Dividends Distributable 10,000

Paid-in Capital in Excess of Par-Common 8,000

Sep. 1 Common Stock Dividends Distributable 10,000

Common Stock 10,000

Small Stock Dividend Versus Large Stock Dividend

• Small Stock Dividend

• A dividend that distributes less than 25% of the number of shares previously outstanding

• Large Stock Dividend

• A dividend that distributes 25% or more of the number of shares previously outstanding

• The Stock Dividends account is debited for the par value of the number of shares issued, not the current market value

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Stock Splits • Corporations sometimes call in their stock and issue two, three, or

more shares in place of each of the shares previously held by the stockholders.

• This process is called a stock split.

• Usually declared to reduce the market price per share, thereby making the stock easier for investors to afford.

• When a company splits its stock:

• The number of shares in the marketplace is increased.

• The share price of the stock is reduced.

• The number of a company’s unissued shares is also increased proportionate to the split.

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Example: Stock Splits

• Hudson Corporation currently has outstanding 50,000 shares of $10 par common stock outstanding.

• Hudson Corporation declares a 2-for-1 split.

• After the stock split, Hudson Corporation has 100,000 shares of $5 par common stock outstanding.

• A memorandum entry may be prepared to record the stock split.

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Appropriation of Retained Earnings

• We have learned that corporations must have sufficient retained earnings before dividends can be declared.

• Even with sufficient retained earnings, the board may want to limit the amount of retained earnings available for dividends.

• The board may vote to earmark or restrict a part of the retained earnings for a specific purpose, referred to as an appropriation of retained earnings.

• Assume the board of directors of Tagen Company decide to build a new building. Also assume on Mar. 1, 20X2, Tagen Company’s board of directors votes to restrict retained earnings at a rate of $60,000 per year for the next 5 years.

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Example: Restricted Retained Earnings

• Tagen Company would record the following journal entry each year:

• The transaction does not change the company’s total retained earnings nor set up a cash fund.

• The journal entry only limits the amount of retained earnings available for dividends.

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20X2

Mar. 1 Retained Earnings 60,000

Retained Earnings Appropriated for Building 60,000

Balance Sheet with Appropriated Retained Earnings

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Retained Earnings Statement A corporation prepares a retained earnings statement as opposed to a statement of owner’s equity for a proprietorship or partnership. Shows the changes in retained earnings for a period of time: (simple)

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Complex Retained Earnings Statement

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