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Chapter 20
Corporate Accounting: Earnings and Distribution
Chapter 20 2
Stockholders’ Equity
Definition: The capital of a corporation.
Consists of paid-in capital and earned capital (or retained earnings).
Chapter 20 3
Stockholders’ Equity
Paid-in capital comes from the assets a corporation receives when it issues stock to investors.
Retained earnings are the earnings of the corporation from past periods that have not been distributed to stockholders.
Chapter 20 4
Net Income of a Corporation
A corporation follows the same basic accounting cycle as a sole proprietorship and a partnership.
At the end of each accounting period, a corporation determines its net income or net loss.
Chapter 20 5
Net Income of a Corporation
This figure is reported on the bottom line of the income statement.
The net income or net loss is the difference between the revenue earned and the costs and expenses incurred during the period.
Chapter 20 6
Closing Entries for a Corporation
The closing process for a corporation consists of three steps.
Step 1. Close the balances of the revenue accounts to Income Summary.
Step 2. Close the balances of the cost and expense accounts to Income Summary.
Step 3. Close the balance of Income Summary (net income or net loss for the period) to Retained Earnings.
Chapter 20 7
Closing the Income Summary Account
At the Bell Corporation, the Income Summary account has a credit balance of $150,000 after the closing of the revenue, cost, and expense accounts.
The $150,000 represents the net income for the year. The final closing entry transfers this amount to Retained Earnings.
Chapter 20 8
Closing the Income Summary Account
Closing Entries
20X3 Dec. 31 Income Summary 150,000 Retained Earnings
150,000
Chapter 20 9
Retained Earnings Account
After the final closing entry is posted on December 31, 20X3, the Retained Earnings account at the Bell Corporation has a credit balance of $270,000.
The $270,000 represents accumulated earnings that have not been distributed to stockholders in the form of dividends.
Chapter 20 10
Retained Earnings Account
Retained Earnings – + 1/1/X3 Bal. 120,000 12/31/X3 Cl. 150,000 1/1/X4 Bal.270,000
Chapter 20 11
Retained Earnings Account
The balance of Retained Earnings is not cash.
This balance represents earnings accumulated by the corporation that have not been paid to stockholders.
The corporation cannot pay out any dividends until the balance of Retained Earnings is above the amount of legal capital.
Chapter 20 12
Remember
Legal capital is equal to the par value or stated value of the shares outstanding.
Chapter 20 13
Corporate Income Tax
Unlike a sole proprietorship or a partnership, a corporation is a separate legal entity and must pay federal income tax on its earnings.
Many states and some localities also impose an income tax on corporations.
Federal income tax rates are progressive. The higher the earnings, the higher the tax rate.
Chapter 20 14
Federal Income Tax Rates
Congress changes federal income tax rates from time to time. We will use the following rates.
Corporate Income Taxable Income Tax Rate $0–$50,000 15% $50,001–$75,000 25 $75,001–$100,000 34 $100,001–$335,000 39 Over $335,000 34
Chapter 20 15
Calculating Corporate Income Tax
Assume a corporation has taxable income of $300,000. It owes federal income tax of $100,250.
Chapter 20 16
Calculating Corporate Income Tax
Taxable Tax Tax Income Rate Owed $ 50,000 .15 = $ 7,500 25,000 .25 = 6,250 25,000 .34 = 8,500 200,000 .39 = 78,000 $300,000 $100,250
Chapter 20 17
Calculating Corporate Income Tax
If the taxable income is above $335,000, simply multiply the entire amount by 34%.
Example: Assume a corporation has a taxable
income of $500,000. $500,000 .34 = $170,000
Chapter 20 18
Paying Corporate Income Tax
At the start of each fiscal year, corporations must estimate their taxable income and the federal income tax they will owe for the year.
Corporations must pay this estimated tax in four quarterly installments during the year.
At the end of the fiscal year, corporations calculate the actual tax owed.
If any additional tax is due, it must be paid in the next 2½ months.
Chapter 20 19
Recording Payment of Estimated Income Tax
The Bell Corporation estimates taxable income of $140,000 for 20X3. Its federal income tax should be $37,850.
The first quarterly installment of $9,462.50 ($37,850 4) is paid on April 15.
Chapter 20 20
Recording Payment of Estimated Income Tax
20X3 Apr. 15 Income Tax Expense9,462.50 Cash
9,462.50 Paid first quarterly installment of estimated federal income tax for year.
Chapter 20 21
Additional Income Tax Owed
On December 31, 20X3, the Bell Corporation finds it had actual taxable income of $150,000 for the year. The Federal income tax owed on this amount is $41,750.
During the year, Bell paid a total of $37,850 in estimated tax.
Bell must now make an adjusting entry to record the $3,900 still owed for federal income tax ($41,750 – $37,850).
Chapter 20 22
Adjustment for Additional Income Tax Owed
The amount of income tax owed at the end of the year is debited to Income Tax Expense and credited to a liability account called Income Tax Payable.
Chapter 20 23
Adjustment for Additional Income Tax Owed
Adjusting Entries
20X3 Dec. 31 Income Tax Expense 3,900 Income Tax Payable
3,900
Chapter 20 24
Dividends
Definition: A distribution of corporate earnings to the stockholders of the company.
Dividends are declared by the board of directors.
The two most common types of dividends are: Cash Dividends Stock Dividends
Chapter 20 25
Cash Dividends
To pay a cash dividend, a corporation must have sufficient retained earnings above its legal capital and sufficient cash above its working capital needs.
There are three important dates connected with a dividend. Date of Declaration Date of Record Date of Payment
Chapter 20 26
Cash DividendDate of Declaration
Definition: The date when the board of directors formally declares a dividend.
On this date, the corporation must make a journal entry to record its legal liability for the dividend.
Chapter 20 27
Recording a Cash Dividend on the Date of Declaration
On January 2, 20X4, the Bell Corporation declared a cash dividend of $1 per share on the 10,000 shares of common stock it has outstanding.
To record this transaction, Bell debits a contra capital account called Cash Dividends and credits a liability account called Dividends Payable.
Chapter 20 28
Recording a Cash Dividend on the Date of Declaration
20X4 Jan. 2 Cash Dividends 10,000 Dividends Payable
10,000 Declared a cash dividend to be paid on March 1.
Chapter 20 29
Cash DividendDate of Record
Definition: The date of record is the date on which the corporation reviews its records to determine who owns shares.
Only stockholders who are listed in the corporation’s records on this date will receive the dividend.
Chapter 20 30
Cash DividendDate of Record
At the Bell Corporation, the date of record is February 1 for the cash dividend declared on January 2.
No journal entry is required on the date of record.
Chapter 20 31
Cash DividendDate of Payment
On the date of payment, the corporation will issue checks to stockholders who owned shares on the date of record.
The entry made to record the payment eliminates the liability for the dividend.
Chapter 20 32
Cash DividendDate of Payment
20X4 Mar. 1 Dividends Payable 10,000 Cash
10,000 Paid cash dividend declared on January 2.
Chapter 20 33
Effect of a Cash Dividend
After a cash dividend is declared and paid, there is a reduction in assets and a reduction in stockholders’ equity.
The asset Cash decreases.At the end of the accounting period, the
balance of the contra capital account Cash Dividends is closed into Retained Earnings.
As a result, the balance of Retained Earnings decreases.
Chapter 20 34
Cumulative Preferred Stock
When preferred stock is cumulative, unpaid dividends accumulate from year to year.
These dividends must be paid in full before any dividends are paid to the owners of the common stock.
Chapter 20 35
Cumulative Preferred Stock
During 20X1, the Nash Corporation did not pay $20,000 of dividends on its cumulative preferred stock.
In 20X2, Nash declared cash dividends of $50,000. Of this amount, $40,000 must go to the owners of the preferred stock: $20,000 for 20X1 and $20,000 for 20X2.
The amount available to pay dividends to the owners of the common stock is $10,000.
Chapter 20 36
Stock Dividends
Sometimes a corporation distributes a stock dividend.
The corporation provides additional shares of its own authorized stock to stockholders.
Stock dividends allow corporations to conserve their cash but maintain a good relationship with their stockholders.
Chapter 20 37
Stock Dividends
Distributed on a pro rata basis.Stockholders receive the additional shares
in proportion to the shares they already own.
Example: If a 10% stock dividend is declared, a
stockholder who owns 500 shares will receive another 50 shares (500 .10).
Chapter 20 38
Stock DividendExample
On April 5, 20X1, the Wells Corporation declares a 10% stock dividend to the owners of its common stock on May 1.
Wells has 20,000 shares of $10 par value common stock outstanding. The market value is $15 per share.
On June 1, 20X1, Wells will issue an additional 2,000 shares of common stock for the stock dividend (20,000 .10).
Chapter 20 39
Recording a Stock Dividend
When the Wells Corporation declares its 10% stock dividend, it debits Stock Dividends for the market value of the shares to be issued (2,000 $15 = $30,000).
Wells credits Common Stock Dividends Distributable for the par value of the shares to be issued (2,000 $10 = $20,000).
Chapter 20 40
Recording a Stock Dividend
Wells credits the difference between the market value and the par value of the shares to be issued to Paid-In Capital in Excess of Par—Common (2,000 $5 = $10,000).
Chapter 20 41
Recording a Stock Dividend
Stock Dividends is a contra capital account. At the end of the accounting period, its balance is closed into Retained Earnings.
Common Stock Dividends Distributable is not a liability account. It is a capital account.
Chapter 20 42
Recording a Stock Dividend
20X1 Apr. 5 Stock Dividends 30,000 Common Stock 20,000 Dividends Distributable Paid-In Cap. in Excess of Par—Common 10,000 Declared a 10% common stock dividend to be distributed on June 1.
Chapter 20 43
Recording a Stock Dividend
On June 1, 20X1, the Wells Corporation makes the following entry when it issues the stock dividend.
After this entry is posted, the balance of Common Stock Dividends Distributable is reduced to zero.
Chapter 20 44
Recording a Stock Dividend
20X1 Jun. 1 Common Stock Dividends Distributable20,000 Common Stock
20,000 Issued stock dividend on April 5.
Chapter 20 45
Effect of a Stock Dividend
After a stock dividend is issued, there is no reduction in assets or stockholders’ equity.
However, the makeup of stockholders’ equity changes.
Chapter 20 46
Effect of a Stock Dividend
There is an increase in the balances of Common Stock and Paid-In Capital in Excess of Par—Common.
There is a decrease in the balance of Retained Earnings (when the balance of Stock Dividends is closed into it).
Chapter 20 47
Stock Splits
Sometimes corporations declare a stock split.
They call in their outstanding stock and issue two, three, or more shares for each of the old shares.
Usually, this is done to reduce a high market price for the stock and make it affordable for more investors.
Chapter 20 48
Stock SplitsExample
On July 1, 20X2, the Chase Corporation declared a 4-for-1 split of its $10 par value common stock.
There were 10,000 shares outstanding, and they had a market price of $200 per share.
Chapter 20 49
Stock SplitsExample
As a result of the stock split, Chase will now have 40,000 shares outstanding with a par value of $2.50 per share.
Initially, the market price will fall to about $50 per share.
Chapter 20 50
Memorandum Entry for a Stock Split
A stock split has no effect on total stockholders’ equity.
Thus, the corporation simply makes a memorandum entry in its journal when the stock split is declared.
Chapter 20 51
Memorandum Entry for a Stock Split
20X2 Jul. 1 Memorandum entry: Declared a 4-for-1 stock split, resulting in 40,000 shares of common stock outstanding with a par value of $2.50 per share.
Chapter 20 52
Appropriation of Retained Earnings
Sometimes the board of directors will appropriate part of retained earnings for a specific purpose, such as construction of a new building.
The appropriation restricts the amount of retained earnings available for dividends.
Chapter 20 53
Appropriation of Retained Earnings
The appropriation does not set up a cash fund.
It notifies stockholders and potential investors of a limitation on dividends for a period of time.
Chapter 20 54
Recording an Appropriation of Retained Earnings
On January 2, 20X1, the Wayne Corporation decides to appropriate $100,000 per year for five years to expand its factory building.
This transaction does not change the total retained earnings. It simply results in a transfer from Retained Earnings to Retained Earnings Appropriated for Factory Expansion.
Chapter 20 55
Recording an Appropriation of Retained Earnings
The Wayne Corporation makes the following entry to record the first of five yearly appropriations for factory expansion.
Chapter 20 56
Recording an Appropriation of Retained Earnings
20X1 Jan. 2 Retained Earnings 100,000 Retained Earnings Appropriated for Factory Expansion
100,000 Appropriated retained earnings to expand factory building.
Chapter 20 57
Ending an Appropriation of Retained Earnings
When the period of the appropriation ends, an entry is made to return the amount of the appropriation to Retained Earnings.
Chapter 20 58
Ending an Appropriation of Retained Earnings
20X6 Jan. 15 Retained Earnings Appropriated for Factory Expansion500,000 Retained Earnings
500,000 Returned appropriation to retained earnings.
Chapter 20 59
The Retained Earnings Statement
At the end of each accounting period, a corporation prepares a retained earnings statement to show changes in retained earnings during the period.
Chapter 20 60
Kent CorporationRetained Earnings Statement
For Year Ended December 31, 20X1
Retained earnings, Jan. 1, 20X1 $400,000 Add: Net income 80,000 $480,000 Less: Dividends 50,000 Retained earnings, Dec. 31, 20X1 $430,000