Chapter 14: Corporations: Dividends, Retained Earnings, and Income Reporting

Question 1

Memorandum entry

Answer 1

An entry in the journal that notes a significant event but has no debit or credit amount. (Stock splits)

Question 2

Appropriation of retained earnings

Answer 2

Restriction of a portion of retained earnings that is recorded by a journal entry

Question 3

Stock Dividends

Answer 3

Pro Rata (proportional) distribution of the corporations own stock - % increase on current qty of shares of stock.
NUMBER of shares increases
PERCENTAGE of company owned by each shareholder stays the same
- No effect on assets or liabilities, only stockholders’ equity.

Reasons to issue:

• satisfy dividend expectations without spending cash
• increase marketability of stock (reduce price)
• to “emphasize that a portion of stockholders’ equity has been permanently reinvested in the business”

Question 4

Dividends in Arrears

Answer 4

Accrued by cumulative preferred stockholders every year declared dividends are less than preferred dividend amount. MUST be paid before common shareholders receive dividends.

NOT a liability. Only becomes a liability after the board declares a dividend. Noted in financial statement.

Question 5

Cumulative vs Non-Cumulative preferred stock

Answer 5

Cumulative: any unpaid prior year’s dividends (aka dividends in arrears) must be paid before common stockholders receive dividends.
- Cumulative preferred stock is the most common type - to the point that preferred stock is assumed to be cumulative unless designated otherwise.

Non-Cumulative: only current years dividends must be paid to preferred shareholders before common stockholders
- If declared dividends are less than preferred dividends non-cumulative preferred stockholders get only the declared amount

Question 6

Dividends: Important Dates

Answer 6

• Declaration date: Board authorizes dividends (record dividends payable journal entry)
• Record date: registered shareholders as of that date are eligible to receive dividends
• Payment date: dividend checks issued (record cash out journal entry)

Question 7

Requirements for Cash Dividends

Answer 7

1) Retained earnings
2) Adequate cash
3) A declaration of dividends by the board of directors

Question 8

Dividends

Answer 8

A distribution of cash or stock to stockholders proportionate to stock held.

Expressed as a percentage of the par stated value or as a dollar amount per share

Cash dividends, property dividends, Promissory note for cash (scrip) dividends, stock dividends

Question 9

Pro Rata

Answer 9

Proportional

Question 10

Retained Earnings Restrictions

Answer 10

Portion of retained earnings unavailable for dividends.
Restrictions from:
- Legal restrictions / State requirements
(some states require RE restrictions for cost of treasury stock)
- Contractual restrictions
- voluntary restrictions (savings for future projects)

All disclose in financial statements

Question 11

Retained Earnings

Answer 11

Net income a company retains for business use.
Net income increases
Net loss decreases
A part of stockholders’ equity

Normal balance = credit
If debit balance = have deficit

Question 12

Stock Split

Answer 12

Issuance of additional shares to stockholders according to their ownership percentage.

• Changes the Par-Value per share!!
• Does not change overall stockholder’s equity
• increases marketability by lowering market value per share (if the price is too high it might be less attractive to investors)
  (vs. using treasury share buyback to increase share price)
• Percentage of company owned stays the same.

Question 13

Journal Entries for Cash Dividends

Answer 13

On Declaration date:
Debit Retained Earnings
Credit Dividends Payable

On Payment Date:
Debit Dividends Payable
Credit Cash

(no entry on date of record)

Question 14

Journal Entry for income tax

Answer 14

income tax expense = income before taxes * tax rate

To accrue:
Debit Income Tax Expense
Credit Income Tax Payable

Question 15

Correcting Prior Period Error

Answer 15

Making a prior period adjustment: direct increase or decrease of retained earnings

Net prior period adjustment = Error amt * (1-tax rate)

If prior period income overstated
Debit Retained Earnings
Credit Correction Account

If prior period income understated
Debit Correction Account
Credit Retained Earnings

Question 16

Deficit

Answer 16

Debit balance in retained earnings

Essentially a small sustained loss not balanced by previous earnings

Question 17

Journaling stock split

Answer 17

No journal entry. Only the total qty of oustanding stock changes

Question 18

Stock Dividends- amount to transfer

Answer 18

Per GAAP the value stock dividends recorded at depends on size.

Less than 20-25% of issued stock = small stock dividend. Recorded at fair market value

Over 20-25% of issued stock = large stock dividend. Recorded at Par Value

Question 19

Stock Dividends

Answer 19

Move value from retained earnings to paid-in capital
1) Debit Retained Earnings (full amount)
Credit Common Stock Dividends Distributable
Credit APIC - Common Stock 9if a small dividend and FMV is over par)

2) Debit Common stock dividends distritbutable
Credit Common stock

This has the same effect on retained earnings as cash dividends

Question 20

Corporate Income Statement

Answer 20

Continuing Operations
Income from Continuing Operations
Discontinued Operations
Net Income

Earnings per share of common stock outstanding
Income from continuing operations
Income from discontinued operations
NET Income

Question 21

Dividends on Fiancial statements

Answer 21

Dividends are not deducted as an expense on the income statement

Stock dividends distributable is shown as an addition to capital stock

Question 22

Retained earnings statement

Answer 22

Details changes in retained earnings over period
- prepares using retained Earnings account

Shows: Cash and stock dividends
net income and loss
SOME disposal of treasury stock below cost (if no balance available in paid-in capital from treasury stock)

Question 23

Statement of stockholder’s equity

Answer 23

• Used instead of a detained stockholders equity section on BS and RE statement

Shows change in each SE Account throughout the year.

Columns: list SE accounts
Rows: shows beginning balance, transactions throughout the period, and ending balance

Question 24

Prior period adjustment on current year retained earnings statement

Answer 24

Shown as adjustment to beginning balance of retained earnings (not on tax)

Question 25

Effect of stock dividend on balance sheet

Answer 25

Total shareholders equity is unchanged (moves from retained earnings to common or preferred stock and APIC)

Number of shares outstanding and book value do change

Cash dividends DO decrease stockholders equity

Question 26

Income tax on income statement

Answer 26

Sales
(less COGS)
= Gross Profit
(less operating expenses)
= income from operations
\+/- other revenue or loss
= income before income taxes
(less Income Tax Expense)
= Net Income

Question 27

Earnings per share

Answer 27

EPS
Net income (minus preferred dividends) / weighted average common shares outstanding (if number of shares has changed during year)

Shows net income earned by each share outstanding of common stock

FASB requires that this is on the income statement

Same under IFRS and GAAP

Question 28

Return on Common Stockholder’s Equity

Answer 28

(ROE)
= Net income available (net income less preferred dividends) / Average common stock holders Equity ((beg+end)/2)

Measures profitability: shows how many dollars of net income the company earned for each dollar invested by shareholders

Question 29

Net of Tax

Answer 29

Full amount * (1-tax rate) = net of tax amount

Question 30

Price/Earnings Ration

Answer 30

Market Price common stock / Earnings per share

Ratio of the market price of a share of common stock to the company’s earnings per share (aka the value the market places on $1.00 of company earnings)

Higher ratio = higher return on investment

Question 31

IFRS Comprehensive Income Statement

Answer 31

Must include income tax expense

Question 32

Cash and Stock Dividends IFRS vs GAAP

Answer 32

Basically the same

Question 33

Previously issued financial statements with errors are required to be restated under

Answer 33

Both GAAP and IFRS.