Accounting Principles Thirteenth Edition Weygandt Kimmel Kieso Chapter 14 Corporations: Dividends, Retained Earnings, and Income Reporting Prepared by Coby Harmon University of California, Santa Barbara Westmont College Chapter Outline Learning Objectives LO Explain how to account for cash dividends, stock dividends, and stock splits LO Discuss how stockholders’ equity is reported and analyzed LO Describe the form and content of corporation income statements Copyright ©2018 John Wiley & Son, Inc Accounting for Dividends and Stock Splits Distribution of cash or stock to stockholders on a pro rata (proportional to ownership) basis Types of Dividends: Cash Property Stock Scrip (promissory note) LO Copyright ©2018 John Wiley & Son, Inc Cash Dividends For a corporation to pay a cash dividend, it must have: Retained earnings - Payment of cash dividends from retained earnings is legal in all states Adequate cash A declaration of dividends by Board of Directors LO Copyright ©2018 John Wiley & Son, Inc Cash Dividends Three dates are important: LO Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 14.1 Key dividend dates Cash Dividends Illustration: On December 1, the directors of Media General declare a 50 cents per share cash dividend on 100,000 shares of $10 par value common stock The dividend is payable on January 20 to shareholders of record on December 22 Dec Cash Dividends 50,000 Dividends Payable 50,000 Dec 22 No entry Jan 20 Dividends Payable 50,000 Cash 50,000 LO Copyright ©2018 John Wiley & Son, Inc Dividend Preferences Right to receive dividends before common stockholders Per share dividend amount is stated as a percentage of preferred stock’s par value or as a specified amount Cumulative Dividend Preferred stockholders must be paid both current-year dividends and any unpaid prior-year dividends before common stockholders receive dividends LO Copyright ©2018 John Wiley & Son, Inc Dividend Preferences Cumulative Dividend Illustration: Scientific Leasing has 5,000 shares of 7%, $100 par value, cumulative preferred stock outstanding Each $100 share pays a $7 dividend (.07 × $100) The annual dividend is $35,000 (5,000 × $7 per share) If dividends are two years in arrears, preferred stockholders are entitled to receive the following dividends Dividends in arrears ($35,000 × 2) $ 70,000 Current-year dividends 35,000 Total preferred dividends $105,000 LO Copyright ©2018 John Wiley & Son, Inc Dividend Preferences Allocating Cash Dividends Between Preferred and Common Stock Holders of cumulative preferred stock must be paid any unpaid prior-year dividends and their current year’s dividend before common stockholders receive dividends LO Copyright ©2018 John Wiley & Son, Inc Allocating Cash Dividends Illustration: On December 31, 2020, IBR Inc has 1,000 shares of 8%, $100 par value cumulative preferred stock It also has 50,000 shares of $10 par value common stock outstanding At December 31, 2020, the directors declare a $6,000 cash dividend Calculate the annual preferred dividend $100 par x 8% x 1,000 shares = $8,000 Prepare the entry to record the declaration of the dividend Dec 31 Cash Dividends 6,000 Dividends Payable 6,000 LO Copyright ©2018 John Wiley & Son, Inc 10 Income Statement Analysis To illustrate, assume that Rally Inc reports net income of $211,000 on its 102,500 weighted-average common shares During the year, it also declares a $6,000 dividend on its preferred stock Therefore, the amount Rally has available for common stock dividends is $205,000 ($211,000 − $6,000) Earnings per share is calculated as follows Net Income minus ÷ Weighted-Average Common = Preferred Dividends Shares Outstanding $211,000 - $6,000 LO ÷ $102,500 Copyright ©2018 John Wiley & Son, Inc = Earnings per Share $2.00 41 DO IT! EPS On January 1, 2020, Siena Corporation purchased 2,000 shares of treasury stock Other information regarding Siena Corporation is provided below 2019 2020 Net income $110,000 $110,000 Dividends on preferred stock 10,000 10,000 Dividends on common stock 2,000 1,600 Weighted-average number of shares outstanding 10,000 8,000* Common stockholders’ equity, beginning of year 500,000 400,000* Common stockholders’ equity, ending of year 500,000 400,000 *Adjusted for purchase of treasury stock Compute earnings per share for each year LO Copyright ©2018 John Wiley & Son, Inc 42 DO IT! EPS Net income Dividends on preferred stock Dividends on common stock Weighted-average number of shares outstanding Common stockholders’ equity, beginning of year Common stockholders’ equity, ending of year *Adjusted for purchase of treasury stock 2019 2020 $110,000 $110,000 10,000 10,000 2,000 1,600 10,000 8,000* 500,000 400,000* 500,000 400,000 Compute earnings per share for each year 2019 ($110,000 – $10,000) $10,000 LO = $10 2020 ($110,000 – $10,000) $8,000 Copyright ©2018 John Wiley & Son, Inc = $12.50 43 Appendix 14A Stockholders’ Equity Hampton Corporation Stockholders’ Equity Statement For the Year Ended December 31, 2020 Common Paid-in Capital Stock in Excess of Retained ($5 par) Par-Common Earnings Balance, January Issued 5,000 shares of common stock at $15 Declared a $40,000 cash dividend Purchased 2,000 shares for treasury at $16 Net income for year Balance, December 31 LO $300,000 25,000 $200,000 $650,000 ILLUSTRATION 14A.1 Treasury Stock $(34,000) $1,116,000 50,000 75,000 (40,000) (40,000) (32,000) $325,000 Total 240,000 $250,000 $850,000 Copyright ©2018 John Wiley & Son, Inc $(66,000) (32,000) 240,000 $1,359,000 44 Appendix 14B Book Value per Share Represents the equity a common stockholder has in the net assets of the corporation from owning one share of stock If Marlo Corporation has total stockholders’ equity of $1,500,000 (common stock $1,000,000 and retained earnings $500,000) and 50,000 shares of common stock outstanding, book value per share is calculated as follows LO Total Stockholders’ Equity $1,500,000 ÷ Number of Common Shares Outstanding = Book Value per Share ÷ 50,000 = $30 Copyright ©2018 John Wiley & Son, Inc 45 Appendix 14B Book Value per Share When the company has both preferred and common stock, the computation of book value per share involves the following steps Compute preferred stock equity The sum of the call price of preferred stock plus any cumulative dividends in arrears If the preferred stock does not have a call price, the par value of the stock is used Determine the common stock equity Subtract the preferred stock equity from total stockholders’ equity Determine book value per share Divide common stock equity by shares of common stock outstanding LO Copyright ©2018 John Wiley & Son, Inc 46 Appendix 14B Book Value per Share Using the stockholders’ equity section of Graber Inc shown in Illustration 14.14, assume Graber’s preferred stock is callable at $120 per share and is cumulative, and that dividends on Graber’s preferred stock were in arrears for one year, $54,000 (6,000 × $9) The computation of preferred stock equity is as follows Call price (6,000 shares × $120) $720,000 Dividends in arrears (6,000 shares × $9) 54,000 Preferred stock equity LO $774,000 Copyright ©2018 John Wiley & Son, Inc 47 Appendix 14B Book Value per Share Using the stockholders’ equity section of Graber Inc shown in Illustration 14.14, assume Graber’s preferred stock is callable at $120 per share and is cumulative, and that dividends on Graber’s preferred stock were in arrears for one year, $54,000 (6,000 × $9) The computation of book value is as follows Common Stockholders’ Equity $4,800,000 - $774,000 LO ÷ Number of Common Shares Outstanding = Book Value per Share ÷ 390,000 = $10.32 Copyright ©2018 John Wiley & Son, Inc 48 Appendix 14B Book Value per Share Book value per share may not equal market price per share The correlation between book value and the annual range of a company’s market price per share is often remote Company The Limited, Inc H J Heinz Company Cisco Systems Wal-Mart Stores, Inc Book-Value (year-end) Market Range (for the year) $13.38 $ 7.48 $ 3.66 $12.79 $31.03-$22.89 $40.61-$34.53 $21.24-$17.01 $50.87-$42.31 ILLUSTRATION 14B.4 Book value and market prices compared LO Copyright ©2018 John Wiley & Son, Inc 49 A Look at IFRS Key Points Similarities The accounting related to prior period adjustment is essentially the same under IFRS and GAAP The stockholders’ equity section is essentially the same under IFRS and GAAP However, terminology used to describe certain components is often different These differences are discussed in Chapter 13 LO Copyright ©2018 John Wiley & Son, Inc 50 A Look at IFRS Key Points Similarities The income statement using IFRS is called the statement of comprehensive income A statement of comprehensive income is presented in a one- or two-statement format The single-statement approach includes all items of income and expense, as well as each component of other comprehensive income or loss by its individual characteristic In the two-statement approach, a traditional income statement is prepared It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items Regardless of which approach is reported, income tax expense is required to be reported LO Copyright ©2018 John Wiley & Son, Inc 51 A Look at IFRS Key Points Similarities The computations related to earnings per share are essentially the same under IFRS and GAAP Differences The term reserves is used in IFRS to indicate all non–contributed (non– paid-in) capital Reserves include retained earnings and other comprehensive income items, such as revaluation surplus and unrealized gains or losses on available-for-sale securities LO IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings The term retained earnings is also often used Copyright ©2018 John Wiley & Son, Inc 52 A Look at IFRS Key Points Differences Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and shareholders’ funds LO Copyright ©2018 John Wiley & Son, Inc 53 A Look at IFRS Looking to the Future The IASB and the FASB are currently working on a project related to financial statement presentation An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements For example, it is likely that the statement of stockholders’ equity and its presentation will be examined closely Both the IASB and FASB are working toward convergence of any remaining differences related to earnings per share computations This convergence will deal with highly technical changes beyond the scope of this textbook LO Copyright ©2018 John Wiley & Son, Inc 54 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Copyright ©2018 John Wiley & Son, Inc 55 ... Describe the form and content of corporation income statements Copyright ©2018 John Wiley & Son, Inc Accounting for Dividends and Stock Splits Distribution of cash or stock to stockholders on a pro... stock dividend (less than 20–25% of corporation’s issued stock, recorded at fair market value) Accounting based on assumption that a small stock dividend will have little effect on market price... issued financial statements b Result from: mathematical mistakes mistakes in application of accounting principles oversight or misuse of facts c Adjustment made to beginning balance of retained