1. Chapter 20 Corporate Accounting: Earnings and Distribution

2. Chapter 202 Stockholders’ Equity Definition: The capital of a corporation. Consists of paid-in capital and earned capital (or retained earnings).

3. Chapter 203 Stockholders’ Equity zPaid-in capital comes from the assets a corporation receives when it issues stock to investors. zRetained earnings are the earnings of the corporation from past periods that have not been distributed to stockholders.

4. Chapter 204 Net Income of a Corporation zA corporation follows the same basic accounting cycle as a sole proprietorship and a partnership. zAt the end of each accounting period, a corporation determines its net income or net loss.

5. Chapter 205 Net Income of a Corporation zThis figure is reported on the bottom line of the income statement. zThe net income or net loss is the difference between the revenue earned and the costs and expenses incurred during the period.

6. Chapter 206 Closing Entries for a Corporation The closing process for a corporation consists of three steps. Step 1. Close the balances of the revenue accounts to Income Summary. Step 2. Close the balances of the cost and expense accounts to Income Summary. Step 3. Close the balance of Income Summary (net income or net loss for the period) to Retained Earnings.

7. Chapter 207 Closing the Income Summary Account zAt the Bell Corporation, the Income Summary account has a credit balance of $150,000 after the closing of the revenue, cost, and expense accounts. zThe $150,000 represents the net income for the year. The final closing entry transfers this amount to Retained Earnings.

8. Chapter 208 Closing the Income Summary Account Closing Entries 20X3 Dec. 31Income Summary150,000 Retained Earnings150,000

9. Chapter 209 Retained Earnings Account zAfter the final closing entry is posted on December 31, 20X3, the Retained Earnings account at the Bell Corporation has a credit balance of $270,000. zThe $270,000 represents accumulated earnings that have not been distributed to stockholders in the form of dividends.

10. Chapter 2010 Retained Earnings Account Retained Earnings – + 1/1/X3 Bal. 120,000 12/31/X3Cl.150,000 1/1/X4Bal.270,000

11. Chapter 2011 Retained Earnings Account zThe balance of Retained Earnings is not cash. zThis balance represents earnings accumulated by the corporation that have not been paid to stockholders. zThe corporation cannot pay out any dividends until the balance of Retained Earnings is above the amount of legal capital.

12. Chapter 2012 Remember Legal capital is equal to the par value or stated value of the shares outstanding.

13. Chapter 2013 Corporate Income Tax zUnlike a sole proprietorship or a partnership, a corporation is a separate legal entity and must pay federal income tax on its earnings. zMany states and some localities also impose an income tax on corporations. zFederal income tax rates are progressive. The higher the earnings, the higher the tax rate.

14. Chapter 2014 Federal Income Tax Rates Congress changes federal income tax rates from time to time. We will use the following rates. Corporate Income Taxable Income Tax Rate $0–$50,000 15% $50,001–$75,00025 $75,001–$100,00034 $100,001–$335,00039 Over $335,00034

15. Chapter 2015 Calculating Corporate Income Tax Assume a corporation has taxable income of $300,000. It owes federal income tax of $100,250.

16. Chapter 2016 Calculating Corporate Income Tax Taxable Tax Tax Income Rate Owed $ 50,000 .15=$ 7,500 25,000 .25=6,250 25,000 .34=8,500 200,000 .39 =78,000 $300,000$100,250

17. Chapter 2017 Calculating Corporate Income Tax If the taxable income is above $335,000, simply multiply the entire amount by 34%. Example: Assume a corporation has a taxable income of $500,000. $500,000 .34 = $170,000

18. Chapter 2018 Paying Corporate Income Tax zAt the start of each fiscal year, corporations must estimate their taxable income and the federal income tax they will owe for the year. zCorporations must pay this estimated tax in four quarterly installments during the year. zAt the end of the fiscal year, corporations calculate the actual tax owed. zIf any additional tax is due, it must be paid in the next 2½ months.

19. Chapter 2019 Recording Payment of Estimated Income Tax zThe Bell Corporation estimates taxable income of $140,000 for 20X3. Its federal income tax should be $37,850. zThe first quarterly installment of $9,462.50 ($37,850  4) is paid on April 15.

20. Chapter 2020 Recording Payment of Estimated Income Tax 20X3 Apr. 15Income Tax Expense9,462.50 Cash9,462.50 Paid first quarterly installment of estimated federal income tax for year.

21. Chapter 2021 Additional Income Tax Owed zOn December 31, 20X3, the Bell Corporation finds it had actual taxable income of $150,000 for the year. The Federal income tax owed on this amount is $41,750. zDuring the year, Bell paid a total of $37,850 in estimated tax. zBell must now make an adjusting entry to record the $3,900 still owed for federal income tax ($41,750 – $37,850).

22. Chapter 2022 Adjustment for Additional Income Tax Owed The amount of income tax owed at the end of the year is debited to Income Tax Expense and credited to a liability account called Income Tax Payable.

23. Chapter 2023 Adjustment for Additional Income Tax Owed Adjusting Entries 20X3 Dec. 31Income Tax Expense3,900 Income Tax Payable3,900

24. Chapter 2024 Dividends Definition: A distribution of corporate earnings to the stockholders of the company. zDividends are declared by the board of directors. zThe two most common types of dividends are: yCash Dividends yStock Dividends

25. Chapter 2025 Cash Dividends zTo pay a cash dividend, a corporation must have sufficient retained earnings above its legal capital and sufficient cash above its working capital needs. zThere are three important dates connected with a dividend. yDate of Declaration yDate of Record yDate of Payment

26. Chapter 2026 Cash Dividend Date of Declaration Definition: The date when the board of directors formally declares a dividend. On this date, the corporation must make a journal entry to record its legal liability for the dividend.

27. Chapter 2027 Recording a Cash Dividend on the Date of Declaration zOn January 2, 20X4, the Bell Corporation declared a cash dividend of $1 per share on the 10,000 shares of common stock it has outstanding. zTo record this transaction, Bell debits a contra capital account called Cash Dividends and credits a liability account called Dividends Payable.

28. Chapter 2028 Recording a Cash Dividend on the Date of Declaration 20X4 Jan. 2Cash Dividends10,000 Dividends Payable10,000 Declared a cash dividend to be paid on March 1.

29. Chapter 2029 Cash Dividend Date of Record Definition: The date of record is the date on which the corporation reviews its records to determine who owns shares. zOnly stockholders who are listed in the corporation’s records on this date will receive the dividend.

30. Chapter 2030 Cash Dividend Date of Record zAt the Bell Corporation, the date of record is February 1 for the cash dividend declared on January 2. zNo journal entry is required on the date of record.

31. Chapter 2031 Cash Dividend Date of Payment zOn the date of payment, the corporation will issue checks to stockholders who owned shares on the date of record. zThe entry made to record the payment eliminates the liability for the dividend.

32. Chapter 2032 Cash Dividend Date of Payment 20X4 Mar. 1Dividends Payable10,000 Cash10,000 Paid cash dividend declared on January 2.

33. Chapter 2033 Effect of a Cash Dividend zAfter a cash dividend is declared and paid, there is a reduction in assets and a reduction in stockholders’ equity. zThe asset Cash decreases. zAt the end of the accounting period, the balance of the contra capital account Cash Dividends is closed into Retained Earnings. zAs a result, the balance of Retained Earnings decreases.

34. Chapter 2034 Cumulative Preferred Stock zWhen preferred stock is cumulative, unpaid dividends accumulate from year to year. zThese dividends must be paid in full before any dividends are paid to the owners of the common stock.

35. Chapter 2035 Cumulative Preferred Stock zDuring 20X1, the Nash Corporation did not pay $20,000 of dividends on its cumulative preferred stock. zIn 20X2, Nash declared cash dividends of $50,000. Of this amount, $40,000 must go to the owners of the preferred stock: $20,000 for 20X1 and $20,000 for 20X2. zThe amount available to pay dividends to the owners of the common stock is $10,000.

36. Chapter 2036 Stock Dividends zSometimes a corporation distributes a stock dividend. zThe corporation provides additional shares of its own authorized stock to stockholders. zStock dividends allow corporations to conserve their cash but maintain a good relationship with their stockholders.

37. Chapter 2037 Stock Dividends zDistributed on a pro rata basis. zStockholders receive the additional shares in proportion to the shares they already own. Example: If a 10% stock dividend is declared, a stockholder who owns 500 shares will receive another 50 shares (500 .10).

38. Chapter 2038 Stock Dividend Example zOn April 5, 20X1, the Wells Corporation declares a 10% stock dividend to the owners of its common stock on May 1. zWells has 20,000 shares of $10 par value common stock outstanding. The market value is $15 per share. zOn June 1, 20X1, Wells will issue an additional 2,000 shares of common stock for the stock dividend (20,000 .10).

39. Chapter 2039 Recording a Stock Dividend zWhen the Wells Corporation declares its 10% stock dividend, it debits Stock Dividends for the market value of the shares to be issued (2,000  $15 = $30,000). zWells credits Common Stock Dividends Distributable for the par value of the shares to be issued (2,000  $10 = $20,000).

40. Chapter 2040 Recording a Stock Dividend zWells credits the difference between the market value and the par value of the shares to be issued to Paid-In Capital in Excess of Par— Common (2,000  $5 = $10,000).

41. Chapter 2041 Recording a Stock Dividend zStock Dividends is a contra capital account. At the end of the accounting period, its balance is closed into Retained Earnings. zCommon Stock Dividends Distributable is not a liability account. It is a capital account.

42. Chapter 2042 Recording a Stock Dividend 20X1 Apr. 5Stock Dividends30,000 Common Stock 20,000 Dividends Distributable Paid-In Cap. in Excess of Par—Common10,000 Declared a 10% common stock dividend to be distributed on June 1.

43. Chapter 2043 Recording a Stock Dividend zOn June 1, 20X1, the Wells Corporation makes the following entry when it issues the stock dividend. zAfter this entry is posted, the balance of Common Stock Dividends Distributable is reduced to zero.

44. Chapter 2044 Recording a Stock Dividend 20X1 Jun. 1Common Stock Dividends Distributable20,000 Common Stock20,000 Issued stock dividend on April 5.

45. Chapter 2045 Effect of a Stock Dividend zAfter a stock dividend is issued, there is no reduction in assets or stockholders’ equity. zHowever, the makeup of stockholders’ equity changes.

46. Chapter 2046 Effect of a Stock Dividend zThere is an increase in the balances of Common Stock and Paid-In Capital in Excess of Par— Common. zThere is a decrease in the balance of Retained Earnings (when the balance of Stock Dividends is closed into it).

47. Chapter 2047 Stock Splits zSometimes corporations declare a stock split. zThey call in their outstanding stock and issue two, three, or more shares for each of the old shares. zUsually, this is done to reduce a high market price for the stock and make it affordable for more investors.

48. Chapter 2048 Stock Splits Example zOn July 1, 20X2, the Chase Corporation declared a 4-for-1 split of its $10 par value common stock. zThere were 10,000 shares outstanding, and they had a market price of $200 per share.

49. Chapter 2049 Stock Splits Example zAs a result of the stock split, Chase will now have 40,000 shares outstanding with a par value of $2.50 per share. zInitially, the market price will fall to about $50 per share.

50. Chapter 2050 Memorandum Entry for a Stock Split zA stock split has no effect on total stockholders’ equity. zThus, the corporation simply makes a memorandum entry in its journal when the stock split is declared.

51. Chapter 2051 Memorandum Entry for a Stock Split 20X2 Jul. 1Memorandum entry: Declared a 4-for-1 stock split, resulting in 40,000 shares of common stock outstanding with a par value of $2.50 per share.

52. Chapter 2052 Appropriation of Retained Earnings zSometimes the board of directors will appropriate part of retained earnings for a specific purpose, such as construction of a new building. zThe appropriation restricts the amount of retained earnings available for dividends.

53. Chapter 2053 Appropriation of Retained Earnings zThe appropriation does not set up a cash fund. zIt notifies stockholders and potential investors of a limitation on dividends for a period of time.

54. Chapter 2054 Recording an Appropriation of Retained Earnings zOn January 2, 20X1, the Wayne Corporation decides to appropriate $100,000 per year for five years to expand its factory building. zThis transaction does not change the total retained earnings. It simply results in a transfer from Retained Earnings to Retained Earnings Appropriated for Factory Expansion.

55. Chapter 2055 Recording an Appropriation of Retained Earnings The Wayne Corporation makes the following entry to record the first of five yearly appropriations for factory expansion.

56. Chapter 2056 Recording an Appropriation of Retained Earnings 20X1 Jan. 2Retained Earnings100,000 Retained Earnings Appropriated for Factory Expansion100,000 Appropriated retained earnings to expand factory building.

57. Chapter 2057 Ending an Appropriation of Retained Earnings When the period of the appropriation ends, an entry is made to return the amount of the appropriation to Retained Earnings.

58. Chapter 2058 Ending an Appropriation of Retained Earnings 20X6 Jan. 15Retained Earnings Appropriated for Factory Expansion500,000 Retained Earnings500,000 Returned appropriation to retained earnings.

59. Chapter 2059 The Retained Earnings Statement At the end of each accounting period, a corporation prepares a retained earnings statement to show changes in retained earnings during the period.

60. Chapter 2060 Kent Corporation Retained Earnings Statement For Year Ended December 31, 20X1 Retained earnings, Jan. 1, 20X1$400,000 Add: Net income80,000 $480,000 Less: Dividends50,000 Retained earnings, Dec. 31, 20X1$430,000