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Corporate Reporting: Income, Earnings per Share, Retained Earnings
To pay dividends, a corporation must: Have enough retained earnings and cash
Declare a dividend payable
Declaration date: Board of directors formally declares dividend
Commits company to a legal obligation
Declaration is recorded:
Cash Dividends
Dec. 1 Cash Dividends - Preferred 50,000
Dividends Payable 50,000
To record declaration of cash dividend
Record date: Ownership of shares is determined
Shareholders of record on this date will receive dividend
No journal entry required
Payment date: Dividend is paid to shareholders and recorded:
Cash Dividends
Jan. 23 Dividends Payable 50,000
Cash 50,000
To record payment of cash dividend
Also called stock dividends Distribution of corporation’s own shares to its
shareholders Does not change assets or shareholders’ equity Satisfies shareholders' dividend expectations
without spending cash Increasing number of shares will cause market
price to decrease and make shares more affordable
Emphasizes that a portion of shareholders’ equity has been permanently retained in the business Therefore unavailable for cash dividends
Share Dividends
Declaration date:
Issue (payment) date:
Entries for Share Dividends
June 30 Share Dividends - Common 75,000
Common Share Dividends Distributable 75,000
To record declaration of 10% stock dividend
Aug. 5 Common Share Dividends Distributable 75,000
Common Shares 75,000
To record issue of 5,000 common shares in a
stock dividend
Involves the issue of additional shares to
shareholders Similar to a stock dividend
Increases the marketability of shares by lowering market value per share Effect on share price is generally inversely
proportional to size of split
Does not affect shareholders’ equity Therefore no entries are required
Stock Splits
Stock Splits
Assets Liabilities Share Capital Retained Earnings
Cash dividend - NE NE -
Stock dividend NE NE + -
Stock split NE NE NE NE
Shareholders' Equity
"-" Decrease "+" Increase "NE" No effect
Cash dividends reduce assets and shareholders’ equity (retained earnings) Stock dividends increase share capital and decrease retained earnings Stock splits have no effect (but do increase number of shares issued)
Income statement for corporations are the same as
proprietorship or a partnership
Major difference is income taxes
Since corporation is a separate legal entity
Affects income statement (income tax expense) and balance sheet (income tax payable)
Corporate Income Taxes
Sales 800,000$
Cost of goods sold 600,000
Gross profit 200,000
Operating expenses 50,000
Income from operations 150,000
Other revenues 10,000
Other expenses 4,000
Income before income tax 156,000
Income tax expense 46,800
Net income 109,200$
LEADS INC.
Income Sta tement
Year Ended December 31, 2008
Corporate Income Taxes
Interperiod tax allocation: Dividing income tax between amounts payable now and payable later Intraperiod tax allocation: Associating income taxes in a period with their related items of income
The cumulative total of income less losses and
less declared dividends since incorporation
Represents part of shareholder’s claim on total assets of a corporation Not a claim on any specific asset (including cash)
May be subject to restrictions that limit the amount that can be paid out as dividends: Contractual restrictions such as debt covenants
Voluntary restrictions imposed by the Board of Directors
Retained Earnings
A prior period adjustment results from: the correction of a material error in reporting net
income in a prior year, or the changing of an accounting principle
Accounting treatment: Use corrected amount or new principle in reporting
results for the current year Disclose cumulative effect of correction/change as an
adjustment to retained earnings, net of tax Correct/restate financial statements for prior periods Disclose effect of change in financial statements
Prior Period Adjustments
Correction is made directly to retained earnings
Since effect of error is now located there (all revenues and expenses have been closed to retained earnings)
Any corrections are net of any income tax effect
Example: overstatement of cost of goods sold
Understatement of inventory, net income (now retained earnings), and income tax payable
Correction of Prior Period Errors
Feb. 12 Merchandise Inventory 10,000
Income Tax Payable (at 30%) 3,000
Retained Earnings 7,000
To adjust foroverstatement of cost of goods sold in a prior period
Occurs when the principle used in current year is
different that that used in prior year
May be voluntary or prescribed (by the CICA)
Usually applied retroactively (prior years restated) unless not practical to do so
Comparative amounts are restated
Retained earnings is adjusted, net of tax
Similar to adjustment for correction of errors
Change in Accounting Principle
Reported in the statement of retained earnings
Adjustment is added to (subtracted from) opening balance of retained earnings, net of income tax effect
Financial statements of prior years are restated to reflect the change
Entries for Accounting Changes
Shows the changes in retained earnings during the
year
Transactions that affect retained earnings:
Statement of Retained Earnings
Debits (Decreases) Credits (Increases)
1. Correction of a prior period error that 1. Correction of a prior period error that
overstated income understated income
2. Cumulative effect of a change in accounting 2. Cumulative effect of a change in accounting
principle that decreased income principle that increased income
3. Net loss 3. Net income
4. Cash dividends
5. Stock dividends
6. Reacquisition of shares
Retained Earnings
Sample Statement of Retained Earnings
Balance, January 1, as previously reported $800,000
Add: Correction for overstatement of cost of goods sold in 2007,
net of $3,000 income tax expense 7,000
Less: Cumulative effect of change in amortizartion method, net of
$7,200 income tax savings (16,800)
Balance, January 1, as adjusted 790,200
Add: Net income 549,800
1,340,000
Less: Cash dividends $100,000
Stock dividends 200,000
Reacquisition of common shares 15,000 315,000
Balance, December 31 $1,025,000
GRABER INC.
Sta te me nt o f Re ta ine d Ea rning s (p a rtia l)
Ye a r End e d De ce mb e r 31, 2008
Also called net income per share
Indicates net income earned by each outstanding common share
Reported on the income statement Formula to calculate:
Weighted average number of common shares = shares issued during the year x the fraction of the year they are outstanding Example: April 1 = 3/12 months if calendar year used
Earnings per Share
Net income less Preferred Dividends
Weighted Average Number of Common Shares
Earnings per Share
Helps investors compare earnings of different
companies
Formula to calculate:
A high PE ratio is an indicator that investors believe the company has good earnings potential
Earnings Performance: Price-Earnings Ratio
Market Price per Share
Earnings per Share
Price-Earnings Ratio ÷ =
Indicates what percentage of earnings a
company is distributing to its shareholders Can be calculated for both common and
preferred shares:
Payout ratios vary with the industry Income trusts: very high ratios
High payout ratios can indicate that a company is not reinvesting enough in its operations
Payout Ratio
Cash Dividends Payout Ratio ÷ = Net income