1. Retained Earnings, Treasury Stock, and the Income Statement
ACCT 202
WEEK 3
CHAPTER 14

2. Retained Earnings and Dividends
Retained Earnings shows the amount of income allowed to accumulate from the beginning of the corporation’s life to the present.
Retained Earnings represents a claim on assets, but it is not cash.

3. Retained Earnings and Dividends
The balance in the Income Summary account is closed to Retained Earnings at period end.
Dividends are distributions to the stockholders.
To declare dividends there must be adequate retained earnings.

4. Account for Stock Dividends.
Objective 1
Account for Stock Dividends.

5. Stock Dividends What are stock dividends?
They are a proportional distribution of a corporation’s own stock to shareholders.
They do not change total stockholders’ equity.
A stock dividend is a transfer of retained earnings to contributed capital.

6. Small Stock Dividend Example
The dividend is valued at the product of the number of shares distributed times the market price at declaration date.
San Diego Company, with 300,000 shares of $2 par value common stock outstanding, declares a 15% stock dividend when the shares are trading at $20.

7. Small Stock Dividend Example
How much stock do the shareholders receive?
300,000 × 15% = 45,000 shares
45,000 at $20 per share = $900,000, and 45,000 at $2 per share = $90,000
What is the entry when the dividend is distributed?

8. Small Stock Dividend Example
Retained Earnings ,000
Common Stock ,000
Paid-in Capital in
Excess of Par ,000
15% common stock dividend distributed

9. Stock Split
This is an increase in the number of authorized, issued, and outstanding shares.
It is a reduction in the par value.
The market value is usually affected proportionately.

10. Stock Split
A 5-for-1 stock split means that the company would have five times as many shares outstanding after the split as it had before.
Each share’s par value would be divided by five.

11. Stock Split Example
Prior to a 5-for-1 split, San Diego Company had 500,000 shares of $10 par common stock authorized and 100,000 issued.
After the split, 2,500,000 are authorized.
500,000 are issued.
What is the par value per share?
$10 ÷ 5 = $2

12. Distinguish Stock Splits
Objective 2
Distinguish Stock Splits
from Stock Dividends.

13. Similarities Between Stock Splits and Stock Dividends
Both increase the number of shares
of stock owned per stockholder.
Neither change the investor’s
cost of the stock they own.
Neither type of income creates
taxable income for the investor.

14. Differences Between Stock Splits and Stock Dividends
A stock dividend shifts an amount from retained earnings to paid-in capital.
The par value per share remains unchanged.
A stock split affects no account balance.
It changes the par value of the stock.
It increases the number of shares of stock authorized, issued, and outstanding.

15. Account for Treasury Stock.
Objective 3
Account for Treasury Stock.

16. Treasury Stock...
…are shares that a company has issued and later reacquired.
Purchasing treasury stock decreases assets and stockholders’ equity.

17. Treasury Stock Example
San Diego Company purchased 1,000 shares of its own $10 par value common stock at $20 per share (500,000 shares are authorized, 10,000 are issued.)
Treasury Stock 20,000
Cash ,000
Purchased 1,000 shares of treasury stock

18. Treasury Stock Example
Stockholders’ Equity
(Before purchase of treasury stock)
Common stock, $10 par, 10,000 issued $100,000
+ Paid-in capital in excess of par ,000
= Total paid-in capital $900,000
+ Retained earnings ,000
= Total stockholders’ equity $950,000

19. Treasury Stock Example
(After purchase of treasury stock)
Common stock, $10 par, 10,000 issued,
9,000 outstanding $100,000
+ Paid-in capital in excess of par ,000
+ Retained earnings ,000
= Subtotal $950,000
– Treasury stock, 1,000 shares ,000
= Total stockholders’ equity $930,000

20. Sale of Treasury Stock Example
No gain or loss is recognized on the sale of treasury shares.
Excess of sales price over cost is credited to Paid-in Capital-Treasury Stock transactions.
Assume that 100 shares of treasury stock are sold at $22.

21. Sale of Treasury Stock Example
Cash ,200
Treasury Stock ,000
Paid-In Capital from
Treasury Stock
Sold 100 shares of treasury stock
What if 100 shares of treasury stock are sold at $18?

22. Sale of Treasury Stock Example
Cash ,800
Paid-In Capital from
Treasury Stock
Treasury Stock ,000
Sold 100 shares of treasury stock

23. Sale of Treasury Stock Example
What if the resale price is less than cost?
Debit Paid-in Capital from Treasury Stock Transactions.
Debit Retained Earnings if the Paid-in Capital from Treasury Stock Transactions is too small.

24. Retirement of Stock...
…decreases the outstanding stock of the corporation.
Retired shares cannot be reissued.
There is no gain or loss on retirement.

25. Report Restrictions on
Objective 4
Report Restrictions on
Retained Earnings.

26. Restrictions on Retained Earnings
Restrictions are reported on the notes to the financial statements.
Appropriations are restrictions on retained earnings that are recorded by formal journal entries.
Retained earnings appropriations are rare.
There are many acceptable variations in format for presenting stockholders’ equity.

27. Variations in Reporting Stockholders’ Equity
The heading Paid-in Capital does not appear.
Preferred stock is often reported in a single amount.
Additional Paid-in Capital appears as a single amount.
Total stockholders’ equity is not specifically labeled.

28. Analyze a Complex Income Statement.
Objective 5
Analyze a Complex Income Statement.

29. The Corporate Income Statement (Continuing Operations)
Allied Corporation
Income Statement
Year Ended December 31, 20xx
Net sales revenue $500,000
Cost of goods sold ,000
Gross profit ,000
Operating expenses ,000
Operating income ,000

30. The Corporate Income Statement (Continuing Operations)
Operating income ,000
Other gains (losses):
Loss on restructuring operations 10,000
Gain on sale of machinery ,000
Income from continuing operations
before income tax ,000
Income tax expense ,000
Income from continuing operations 54,000

31. The Corporate Income Statement (Special Items)
Discontinued operations income of
$35,000, less income tax of $14, ,000
Income before extraordinary item
and cumulative effect of change in
depreciation method ,000
Extraordinary flood loss, $20,000,
less income tax savings of $8, –12,000
Cumulative effect of change in
depreciation method, $10,000,
less income tax of $4, ,000
Net income $69,000

32. The Corporate Income Statement (Earnings per Share)
Earnings per share of common stock
(20,000 shares outstanding):
Income from continuing operations $2.70
Income from discontinued operations
Income before extraordinary item
and cumulative effect of change
in depreciation method
Extraordinary loss –0.60
Cumulative effect of change in
depreciation method
Net income $3.45

33. Analyzing the Corporate Income Statement
Extraordinary items are both unusual and infrequent.
They are reported net of their tax effect.
The environment must be considered when determining whether an item is unusual.
Accounting rules specify extraordinary items.

34. Analyzing the Corporate Income Statement
Extraordinary items include expropriations.
Also, they include losses due to natural disasters.
hurricane
flood
fire

35. Analyzing the Corporate Income Statement
Changes in accounting methods can result from either of two scenarios:
Adoption of a newly required accounting standard
Changing accounting methods

36. Earnings Per Share Example
On January 1, San Diego Company had 100,000 common shares outstanding.
On May 1, the company purchased 15,000 treasury shares.
On September 1, they issued 50,000 new shares.
Income for the year was $135,000.
What are the earnings per share?

37. Earnings Per Share Example
No. of Shares Fraction Weighted
Outstanding of Year Average
100,000 × 4/12 = 33,333
85,000 × 4/12 = 28,333
135,000 × 4/12 = 45,000
Total ,666
EPS = $135,000 ÷ 106,666 = $1.27

38. Earnings Per Share and Preferred Stock
Preferred dividends must be subtracted from income subtotals (income from continuing operations, income before extraordinary items, and net income) in the computation on EPS.
They are not subtracted from income or loss from discontinued operations, or from extraordinary gains or losses.

39. Earnings Per Share and Preferred Stock
Corporations with complex capital structures present two sets of EPS amounts.
EPS based on outstanding common shares (basic EPS)
EPS based on outstanding common shares plus the number of additional common shares that would arise from conversion of the preferred stock

40. Reporting Comprehensive Income
FASB Statement 130 requires companies with certain gains and losses to report a comprehensive income figure.
Comprehensive income is the company’s change in total stockholders’ equity from all sources other than from the owners of the business.

41. Reporting Comprehensive Income
FASB 130 New Comprehensive
Income Components
Unrealized gains or losses
on certain investments
Foreign-currency
translation adjustment

42. Prior Period Adjustments...
are corrections to the beginning balance of Retained Earnings for errors of an earlier period.
The correcting entry includes a debit or credit to Retained Earnings for the error amount.
It also includes a debit or credit to the asset or liability account that was misstated.

43. Statement of Retained Earnings Example
De Graff Corporation
Year Ended December 31, 20x5
Retained earnings, Dec 31, 20x4 (original) $390,000
Less: Prior-period adjustments – to correct
error in the 20x4 income tax ,000
Retained earnings, Dec. 31, 20x4, adjusted $380,000
Net income for 20x ,000
Total $494,000
Deduct: Dividends declared in 20x ,000
Retained earnings, December 31, 20x5 $453,000

44. Objective 6
Prepare a Statement of
Stockholders’ Equity.

45. Statement of Stockholders’ Equity
Most companies report a statement of stockholders’ equity, which is more comprehensive than a statement of retained earnings.

46. Statement of Stockholders’ Equity...
…reports changes in all categories of equity during the period.
It reports stock transactions, dividends, and the effects of treasury stock transactions.

47. Statement of Stockholders’ Equity Example
Additional
Common Paid-in Retained
Stock Capital Earnings
Balance, December 31, 20x4 $ 80,000 $160,000 $130,000
Issuance of stock , ,000
Net income ,000
Cash dividends (21,000)
Stock dividends – 8% , , (34,000)
Purchase of treasury stock
Sale of treasury stock ,000
Balance, December 31, 20x5 $108,000 $264,000 $144,000

48. Statement of Stockholders’ Equity Example
Treasury
Stock Total
Balance, December 31, 20x4 $(25,000) $345,000
Issuance of stock ,000
Net income ,000
Cash dividends (21,000)
Stock dividends – 8%
Purchase of treasury stock (9,000) (9,000)
Sale of treasury stock , ,000
Balance, December 31, 20x5 $(30,000) $486,000

49. When a corporation declares a stock dividend:
REVISION QUESTIONS
When a corporation declares a stock dividend:
total assets increase
stockholders’ equity increases
stockholders’ equity remains unchanged
total liabilities increase

50. The board declares a 10% dividend on 1,000 shares of $1 par value common stock. The current selling price of the stock is $10.The journal entry includes a:
debit to retained earnings for $1,000
debit to retained earnings for $100
credit to dividend payable for $900
credit to common stock for $900

51. The board declares a 10% dividend on 1,000 shares of $1 par value common stock. The current selling price of the stock is $10. The journal entry includes a credit to Paid-in capital in excess of par for how much?

52. A 2-for-1 stock split does not:
Cut par value per share in half
Double the number of shares of stock authorized and issued
Double total stockholders’ equity
Leave all account balances unchanged

53. Alfa Corporation purchases 1,000 shares of its own $1 par common stock for $11 per share. The journal entry is:
Debit Treasury Stock; Credit Cash for $11,000
Debit Treasury Stock, $1,000; Debit Paid-in Capital from Treasury Stock, $10,000, Credit Cash, $11,000
Debit Common Stock; Credit Cash, $11,000
Debit Common Stock, $1,000; Debit Paid-in Capital in Excess of Par, Common, $10,000; Credit Cash, $11,000

54. Which statement is not true about Treasury Stock?
Treasury Stock is reported beneath Retained Earnings in the stockholders equity section of the balance sheet.
Treasury Stock carries a vote and receives dividends.
The number of shares outstanding = Number of issued shares – number of treasury shares.
Treasury Stock has a debit Balance.

55. Morris Corporation buys 100 shares of treasury stock for $10 per share
Morris Corporation buys 100 shares of treasury stock for $10 per share. Morris sells the 100 shares for $11 per share. The journal entry would include a:
Credit Paid-in Capital from Treasury Stock Transactions, $100
Credit Paid-in Capital from Treasury Stock Transactions, $1,100
Credit Paid-in Capital from Treasury Stock Transactions, $1,000
Debit Paid-in Capital from Treasury Stock Transactions $100

56. A gain on sale of machinery would appear on the income statement as:
an extraordinary gain.
a component of income from discontinuous operations.
a component of income from continuous operations.
a component of net sales.

57. A loss from an earthquake would probably be classified on an income statement as an:
operating expense
other expense
adjustment to inventory
extraordinary item

58. Use the following information about Norris Company to calculate EPS
Use the following information about Norris Company to calculate EPS. Net income $10,000 6%, $10 Par, Preferred Stock 5,000 Common Stock, $5 par 1,000