1. Prepared by Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

2. C H A P T E R 17 Shareholders’ Equity: Retained Earnings

3. Learning Objectives 1. Describe the policies used in distributing dividends. 2. Identify the various forms of dividend distributions. 3. Explain the accounting for stock dividends. 4. Distinguish between stock dividends and stock splits. 5. Explain the effect of different types of preferred stock dividends.

4. Learning Objectives 6. Identify the reasons for appropriating retained earnings. 7. Explain accounting and reporting for appropriated retained earnings. 8. Indicate how shareholders’ equity is presented and analysed.

5. Shareholders’ Equity: Retained Earnings Retained Earnings Presentation and Analysis of Shareholders’ Equity Presentation Analysis Dividend Policy Legality of dividends Financial condition and dividend distributions Types of dividends Stock split Effect of dividend preferences Appropriation of Retained Earnings Recording appropriations Disclosure of restrictions Trends in terminology

6. Represents the accumulated increase in net assets from profits generated (or decrease when a loss exists), net of distributions to shareholders in the form of dividends. Most common items posted through Retained Earnings Net loss Retroactive adjustments from changes in accounting principles or error corrections Cash, or scrip dividends Stock dividends Property dividends Some treasury stock transactions Net income Retroactive adjustments from changes in accounting principles or error corrections Adjustments due to financial reorganization Retained Earnings

7. Earnings not retained by the corporation for reinvestment in the operations of the business are distributed to shareholders as dividends Not all retained earnings are paid out as dividends, not due to contractual obligations but for management reasons such as: Lack of cash Agreements with creditors to retain earnings to provide protection for the creditors To internally finance growth or expansion (referred to as internal financings or “plowing” profits back into the business) To smooth our dividend payments over a period of time To provide a cushion against possible losses Legal restrictions Dividend Policy

8. Legality of Dividends Two questions need to be answered when considering the declaration of dividends: 1.Is the corporation in a position where a dividend is legally permissible? 2.Is the corporation in a position where a dividend is economically sound?

9. Retained Earnings has a sufficient balance, taking into consideration any legal restrictions on the balance The corporation will not be made insolvent as a result of the dividends Liabilities due in the upcoming year can be made Realizable value of the assets will not be less than the total liabilities + stated capital Deficits must be eliminated before the payment of any dividends The dividends do not reduce Retained Earnings below the cost of any Treasury Shares (this provision exists in most jurisdictions) Legality of Dividends

10. Cash Dividends Property Dividends Scrip Dividends Liquidating Dividends Stock Dividends Types of Dividends

11. Cash Dividend Increase Liabilities Decrease Equity Decrease Liabilities Decrease Cash Property Dividend Increase Liabilities Decrease Equity Decrease Liabilities Decrease Assets Scrip Dividend Increase Liabilities Decrease Equity Decrease Liabilities Decrease Cash Stock Dividend No net effect on Equity Increase Share Capital Decrease Retained Earnings Net Effect - None Declaration Date Payment or Distribution Date Dividend Effect on the Balance Sheet

12. Cash Dividends: Important Dates There are three important dates: the declaration date ( dividends are declared and accrued) the date of record ( list of stockholders to whom dividends are to be paid is finalized) the payment date ( dividends are paid to stockholders of record ) Dividend becomes a current liability on the declaration date

13. Cash Dividends: Journal Entries Date of Record No Entry Date Declared Retained Earnings Dividends Payable Date of Payment Dividends Payable Cash

14. Par value share dividends are often expressed as a percentage of the par value amount Cash dividends declared on preferred shares are in substance financial liabilities; those dividends are treated as interest on long-term debt Dividends are declared only on issued and outstanding shares Treasury shares, cancelled/retired shares or subscribed shares not fully paid for do not receive dividends Cash Dividends

15. When assets other than cash are distributed to shareholders as a dividend (dividend in kind) Distribution of investment securities is the usual form Are a nonreciprocal transfer of nonmonetary assets between an enterprise and its owners Nonreciprocal transfer: a transfer of assets or services in one direction … without consideration Property Dividends

16. Recorded at the fair value of the asset given up (except in spin-offs and reorganizations) Corporation recognizes gain/loss on the distribution (except in spin-offs and reorganizations)

17. On declaration date the following entries are made: AssetDr. if FMV > BVCr. If FMV < BV Gain/Loss on Appreciation of Assets Property Dividend DeclaredAmt. of Dividend Property Dividend PayableAmt. of Dividend On Distribution Date Property Dividend Payable$$$$ Asset $$$$ Property Dividends

18. Given: Company distributes certain marketable securities to shareholders Dividend is declared on Dec 28, 2001 and is distributable on Jan 30, 2002 to shareholders of record on Jan 15, 2002 Cost of securities Dec 28, 2001 = $1,250,000 Fair value of securities Dec 28, 2001 = $2,000,000 Provide the journal entries on the dates of declaration, record, and payment. Property Dividends: Entries

19. 1 Declaration Date Investments 750,000 Gain on Apprec. 750,000 2 Declaration Date Retained Earnings 2,000,000 Prop. Div. Pay. 2,000,000 3 Payment Date Prop. Div. Pay 2,000,000 Investments 2,000,000 Property Dividends: Entries

20. Dividend is payable at some future date, but is accrued now Scrip dividend is a special form of note payable Recipient of scrip can hold it or sell it Interest is paid on scrip until dividend is paid at a later date Such payment is interest, not dividend Scrip Dividends

21. Given: Scrip dividend is declared on 2,545,000 shares at $0.80 per share on May 27 Notes payable is issued for dividends payable on July 27 Interest is payable at 10% Provide the journal entries on the declaration and payment dates. Scrip Dividends: Entries

22. Declaration Date May 27 Retained Earnings 2,036,000 Notes Payable 2,036,000 ($.80 * 2,545,000) Payment Date July 27 Notes Payable 2,036,000 Interest Expense 33,933 Cash 2,036,000 (2,036,000 * 2/12 *.10) Scrip Dividends: Entries

23. When the total dividend declared is greater than the balance of retained earnings Liquidating dividend = Retained Earnings + an amount from Contributed Surplus A liquidating dividend should be clearly disclosed to shareholders; this type of dividend is returning a portion of their investment, rather than a simple return on investment Note that the journal entry on declaration date includes a debit to Contributed Surplus Liquidating Dividends

24. Dividend is paid in the form of additional shares Shareholders maintain their proportionate ownership of the corporation Corporation retains cash (or other assets) while maintaining dividends May have an effect on the market value of the share, but only if the stock dividend is a large one Stock Dividends

25. Book value of each share is decreased due to the increased number of outstanding shares Shareholders individual total book value remains the same The FMV = market price of the share on the date of declaration is used to determine the value of the stock dividend No liability is created when the stock dividend is declared The accounts which form the journal entry on declaration date are equity accounts Stock Dividends

26. Given: A company currently has 1,000 common shares outstanding Retained Earnings = $50,000 December 15, 2000 the Board of Directors declares a 10 percent stock dividend distributable on January 2, 2001 to all shareholders of record on December 27, 2000 The market value of the shares on December 15 is $130.00 What is the significance of the three dates which are underlined in the information given? Stock Dividends

27. Declaration Date Retained Earnings 13,000 Common Stock Dividend Distributable13,000 Distribution Date Common Stock Dividend Distributable13,000 Common stock 13,000 Stock dividend = 10% of 1,000 shares = 100 shares Fair Value = 100 * $130.00 = $130,000 Stock Dividends

28. Motive is to manipulate market value of the shares A stock split will reduce the market value by increasing the number of shares outstanding A reverse stock split increases the market value by decreasing the number of shares outstanding The shareholders’ proportionate ownership remains the same after the stock split No journal entry required for a stock split Memo entry created to indicate the change in the number of shares issued and outstanding Stock Splits

29. No change in the share capital or retained earnings accounts Only change is the number of shares outstanding Increase in the share capital account, decrease in the retained earnings account Net change to shareholders’ equity is nil The number of outstanding shares increases If the Board of Directors should declare a stock dividend of 25 percent or more, this is deemed to be a stock split and should be accounted for in that manner. Stock splitStock dividend Stock Dividend vs. Stock Split

30. Preferred Stock Dividends Cumulative Participating Non-Participating Non-Cumulative Participating Non-Participating

31. Preferred Stock Dividends Given: $50,000 to be distributed as cash dividends Common shares share capital $400,000 Preferred shares outstanding 1,000 shares Share capital value $100,000 Stated dividend $6.00 per share Dividends have not been declared for the previous 2 years

32. Non-Cumulative, Non-Participating PreferredCommonTotal 1000 * $6.00$6,000 Balance to Common $44,00044,000 Totals$6,000$44,000$50,000 Preferred share dividends are calculated and paid before common share dividends With non-cumulative shares no distribution of dividends in arrears is required

33. Cumulative, Non-Participating PreferredCommonTotal Dividends in arrears 1000 * $6.00 * 2 years $12,000 1000 * $6.006,000$6,000 Balance to Common$32,00032,000 Totals$18,000$32,000$50,000 Preferred share dividend arrears are calculated and paid before any other dividends

34. Participating Preferred Calculation steps: 1.Pay out the “regular” preferred dividends (including any arrears) 2.Pay out to the common shareholders an amount equal to the “return rate” earned by the preferred shareholders 3.The balance is then available for participation by preferred shareholders Shared by both preferred and common Participation is based on pro-rata share of share capital

35. Non-Cumulative, Participating PreferredCommonTotal 1000 * $6.00$6,000 ‘Like’ amount paid to common $400,000 * 6% $24,00024,000 Balance available for participation Preferred = 4.0% * $100,000 Common = 4.0% * $400,000 4,00016,00020,000 Totals$10,000$40,000$50,000 Rate of return earned by preferred = Current Dividend  Share Capital = $6,000  $100,000 = 6% This rate of return is paid to the common shareholders prior to the participation dividend being paid out. Participation rate = (Balance of dividends  Total Share Capital) =(50,000-[6,000+24,000])  (100,000+400,000) = 4.0% Each share category then receives an amount = Rate * Share Capital

36. Cumulative, Participating PreferredCommonTotal Dividends in arrears: 1000 * $6.00 * 2$12,000 1000 * $6.00$6,000 “Like” amount paid to common $400,000 * 6% (Note this calculation does not change with cumulative!) $24,00024,000 Total to be paid out prior to participation42,000 Balance available for participation Participation Rate = $8,000  $500,000 = 1.6% Preferred = 1.6% * $100,000 Common = 1.6% * $400,000 4,00016,0008,000 Totals$10,000$40,000$50,000

37. Reclassification of Retained Earnings for a specific purpose Retained Earnings which are restricted cannot be distributed as dividends Retained Earnings (unappropriated) is debited by the amount of the appropriation A separate Retained Earnings account is established for each specific purpose Appropriation of Retained Earnings

38. Appropriations arise from: Statutory or contractual obligations Discretionary action by management and the Board of Directors Possible or expected losses Protection of working capital Neither the appropriation nor the return to un- appropriated Retained Earnings has no effect on total Shareholders’ Equity CICA Handbook recommends the use of the term reserves is limited to appropriations of retained earnings or other surplus

39. Reporting from Appropriations Retained Earnings restrictions, whether legal or discretionary, are disclosed by a note to the financial statements, and most often include the following information: Source of the restriction Relevant provisions Amount of retained earnings restricted, or not restricted

40. Relates to self-sustaining foreign subsidiaries When the amounts related to these subsidiaries are carried on the controlling corporations financial statement, they are carried at the current Canadian dollar amount This exchange rate changes from period to period The translation difference, from period to period, is charged or credited to a Cumulative Translation Adjustment account This account is part of the Shareholders’ Equity section of the balance sheet If there are significant exchange gains/losses in a period this is disclosed in the notes to the statements Cumulative Translation Adjustments

41. CICA Handbook, Section 3250 recommends that the following information be disclosed Changes in each Contributed Surplus source Changes in Retained Earnings Changes in Retained Earnings Appropriations Changes in Share Capital (CICA Handbook, Section 3240) Reporting Shareholders’ Equity

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