11- 1 INCOME AND CHANGES IN RETAINED EARNINGS Chapter 12

12-2 Information about net income can be divided into two major categories Income from continuing operations. Reporting the Results of Operations

12-3 This tax expense does not include effects of unusual, nonrecurring items. These unusual, nonrecurring items are each reported net of taxes.

12-4 When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement. Discontinued Operations

12-5 A segment must be a separate line of business activity or an operation that services a distinct category of customers. Discontinued Operations When management enters into a formal plan to sell or discontinue a segment of the business, the related gains and losses must be disclosed on the income statement.

12-6 During 2011, Matrix, Inc. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of $150,000 and a loss on the sale of its assets of $100,000. Matrix reported income from continuing operations of $1,750,000. All items are taxed at 30%. How will this appear on the income statement? During 2011, Matrix, Inc. sold an unprofitable segment of the company. The segment had a net loss from operations during the period of $150,000 and a loss on the sale of its assets of $100,000. Matrix reported income from continuing operations of $1,750,000. All items are taxed at 30%. How will this appear on the income statement? Discontinued Operations

12-7 Discontinued Operations

12-8 Income Statement Presentation: Discontinued Operations

12-9 Extraordinary Items Material in amount. Gains or losses that are both unusual in nature and not expected to recur in the foreseeable future. Reported net of related taxes.

12-10 During 2011, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Chicago. This was considered an extraordinary item. The company reported income before extraordinary item of $1,575,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2011 income statement? During 2011, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Chicago. This was considered an extraordinary item. The company reported income before extraordinary item of $1,575,000. All gains and losses are subject to a 30% tax rate. How would this item appear on the 2011 income statement? Extraordinary Items

12-11 Income Statement Presentation: Extraordinary Items

12-12 A measure of the company’s profitability and earning power for the period. Based on the number of shares issued and the length of time that number remained unchanged. Earnings Per Share (EPS)

12-13 Remember that Matrix, Inc. has income from continuing operations of $1,750,000. The after-tax loss from discontinued operations was $175,000 and the extraordinary loss was $52,500. Assume that Matrix has 156,250 weighted average shares outstanding. Let’s prepare a partial income statement using all this information. Remember that Matrix, Inc. has income from continuing operations of $1,750,000. The after-tax loss from discontinued operations was $175,000 and the extraordinary loss was $52,500. Assume that Matrix has 156,250 weighted average shares outstanding. Let’s prepare a partial income statement using all this information. Earnings Per Share (EPS)

12-14 * Rounded. Earnings Per Share (EPS) $1,750,000 ÷ 156,250

12-15 If preferred stock is present, subtract preferred dividends from net income prior to computing EPS. EPS is required to be reported in the income statement. Earnings Per Share (EPS)

12-16 Declared by Board of Directors. Not legally required. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. Cash Dividends

12-17 Dividend Dates Date of Declaration Board of Directors declares the dividend. Record a liability. On March 1, 2011, the Board of Directors of Matrix, Inc. declares a $1.00 per share cash dividend on its 500,000 common shares outstanding. The dividend is payable to stockholders of record on April 1, and paid on May 1.

12-18 Dividend Dates Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. NO ENTRY

12-19 Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) Dividend Dates X April 2011

12-20 Date of Payment Record the payment of the dividend to stockholders. Date of Payment Record the payment of the dividend to stockholders. Dividend Dates

12-21 On June 1, 2011, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. On June 1, 2011, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. Dividend Dates

12-22 On June 1, 2011, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. On June 1, 2011, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preferred stock. The dividend will be paid on July 15. Which of the following will be included in the July 15 entry? a. Debit Retained Earnings $20,000. b. Debit Dividends Payable $20,000. c. Credit Dividends Payable $20,000. d. Credit Preferred Stock $20,000. Dividend Dates $100 × 8% = $8 dividend per share $8 × 2,500 = $20,000 total dividend $100 × 8% = $8 dividend per share $8 × 2,500 = $20,000 total dividend

12-23 All stockholders retain same percentage ownership. No change in total stockholders’ equity. No change in par values. Stock Dividends Distribution of additional shares of stock to stockholders.

12-24 Entries to Record Stock Dividends In accounting for a small stock dividend (less than 20%), the market value of the new shares is transferred from Retained Earning account to the paid-in capital accounts. This process is sometimes called “capitalizing” retained earnings. On June 1, Aspen Corporation has outstanding 1,000,000 shares of $1 par value common stock with a market value of $25 per share. The company declares a 5% stock dividend on this date. The dividend is distributable on July 15 to stockholders of record on June 20. Let’s look at the journal entries.

12-25 Entries to Record Stock Dividends

12-26 Dividend Dates Date of Declaration Board of Directors declares the dividend. Do not record a liability. 50,000 shares × $1 par value

12-27 Dividend Dates Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. NO ENTRY

12-28 Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) Dividend Dates X June 2011

12-29 Date of Payment Record the payment of the dividend to stockholders. Date of Payment Record the payment of the dividend to stockholders. Dividend Dates

12-30 Reasons for Stock Dividends Management often finds stock dividends appealing because they allow management to distribute something of perceived value to stockholders while conserving cash which may be needed for other purposes. Stockholders like stock dividends because they receive more shares, often the stock price does not fall proportionately, and the dividend is not subject to income taxes (until the shares received are sold).

12-31 Distinction between Stock Splits and Stock Dividends The difference between a stock dividend and a stock split lies in the intent of management and the related issue of the size of the distribution. A stock dividend usually is intended to substitute for a cash dividend and is small enough that the market price of the stock is relatively unaffected. Stock dividends do not result in a change in the par value of the stock. On the other hand, stock splits result in a pro rata reduction in the par value of the stock.

12-32 Summary of Effects of Stock Dividends and Stock Splits

12-33 Adjust retained earnings retroactively. The adjustment should be disclosed net of any taxes. The correction of an error identified as affecting net income in a prior period. Prior Period Adjustments

12-34 Statement of Retained Earnings with Prior Period Adjustment

12-35 Restrictions of Retained Earnings If I loan your company $1,000,000, I will want you to restrict your retained earnings in order to limit dividend payments. Loan agreements can include restrictions on paying dividends below a certain amount of retained earnings.

12-36 Issuance of new shares of stock. Net Income or Net Loss Payment of Dividends GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments. Comprehensive Income Normally, there are 3 ways that financial position can change.

12-37 Comprehensive Income GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute “Comprehensive Income.”

12-38 Statement of Stockholders’ Equity This is a more inclusive statement than the statement of retained earnings.

12-39 Stockholders’ Equity Section of the Balance Sheet

12-40 End of Chapter 12