Owning a Piece of the Action
Van Meter Industrial, Inc., an electrical-parts distributor in Cedar Rapids, Iowa, is 100% employee-owned. For many years, the company has issued bonuses in the form of shares of company stock to all of its employees. These bonus distributions typically have a value equal to several weeks of pay. Top management always thought that this was a great program. Therefore, it came as quite a surprise a few years ago when an employee stood up at a company-wide meeting and said that he did not see any real value in receiving the company's shares. Instead, he wanted “a few hundred extra bucks for beer and cigarettes.”
As it turned out, many of the company's 340 employees felt this way. Rather than end the stock bonus program, however, the company decided to educate its employees on the value of share ownership. The employees are now taught how to determine the worth of their shares, the rights that come with share ownership, and what they can do to help increase the value of those shares.
As part of the education program, management developed a slogan, “Work ten, get five free.” The idea is that after working 10 years, an employee's shares would be worth the equivalent of about five years’ worth of salary. For example, a person earning a $30,000 salary would earn $300,000 in wages over a 10-year period. During that same 10-year period, it was likely that the value of the employee's shares would accumulate to about $150,000 (five years’ worth of salary). This demonstrates in more concrete terms why employees should be excited about share ownership.
A 12-member employee committee has the responsibility of educating new employees about the program. The committee also runs training programs so that employees understand how their cost-saving actions improve the company's results—and its stock price. It appears that the company's education program to encourage employees to act like owners is working. Profitability has increased rapidly, and employee turnover has fallen from 18% to 8%. Given Van Meter's success, many of the 10,000 other employee-owned companies in the United States might want to investigate whether their employees understand the benefits of share ownership.
Source: Adapted from Simona Covel, “How to Get Workers to Think and Act Like Owners,” Wall Street Journal Online (February 15, 2008).
Scan Learning Objectives
Read Feature Story
Read Preview
Read text and answer DO IT! p. 653 p. 657 p. 661 p. 664
Work Comprehensive DO IT! p. 665
Review Summary of Learning Objectives
Answer Self-Test Questions
Complete Assignmentas
Go to WileyPLUS for practice and tutorials
Read A Look at IFRS p. 682
After studying this chapter, you should be able to:
[1] Prepare the entries for cash dividends and stock dividends.
[2] Identify the items reported in a retained earnings statement.
[3] Prepare and analyze a comprehensive stockholders’ equity section.
[4] Describe the form and content of corporation income statements.
[5] Compute earnings per share.
Preview of Chapter 14
As indicated in the Feature Story, a profitable corporation like Van Meter Industrial, Inc. can provide real benefits to employees through its stock bonus plan. And as employees learn more about the role of dividends, retained earnings, and earnings per share, they develop an understanding and appreciation for what the company is providing to them.
The content and organization of Chapter 14 are as follows.
Dividends
A dividend is a corporation's distribution of cash or stock to its stockholders on a pro rata (proportional to ownership) basis. Pro rata means that if you own 10% of the common shares, you will receive 10% of the dividend. Dividends can take four forms: cash, property, scrip (a promissory note to pay cash), or stock. Cash dividends predominate in practice. Also, companies declare stock dividends with some frequency. These two forms of dividends are the focus of discussion in this chapter.
Investors are very interested in a company's dividend practices. In the financial press, dividends are generally reported quarterly as a dollar amount per share. (Sometimes they are reported on an annual basis.) For example, Nike's quarterly dividend rate in the fourth quarter of 2011 was 36 cents per share. The dividend rate for the fourth quarter of 2011 for GE was 15 cents, and for ConAgra Foods it was 24 cents.
Cash Dividends
A cash dividend is a pro rata distribution of cash to stockholders. Cash dividends are not paid on treasury shares. For a corporation to pay a cash dividend, it must have the following.
- Retained earnings. The legality of a cash dividend depends on the laws of the state in which the company is incorporated. Payment of cash dividends from retained earnings is legal in all states. In general, cash dividend distributions from only the balance in common stock (legal capital) are illegal.
A dividend declared out of paid-in capital is termed a liquidating dividend. Such a dividend reduces or “liquidates” the amount originally paid in by stockholders. Statutes vary considerably with respect to cash dividends based on paid-in capital in excess of par or stated value. Many states permit such dividends.
- Adequate cash. The legality of a dividend and the ability to pay a dividend are two different things. For example, Nike, with retained earnings of over $5.8 billion, could legally declare a dividend of at least $5.8 billion. But Nike's cash balance is only $1.9 billion.
Before declaring a cash dividend, a company's board of directors must carefully consider both current and future demands on the company's cash resources. In some cases, current liabilities may make a cash dividend inappropriate. In other cases, a major plant expansion program may warrant only a relatively small dividend.
- Declared dividends. A company does not pay dividends unless its board of directors decides to do so, at which point the board “declares” the dividend. The board of directors has full authority to determine the amount of income to distribute in the form of a dividend and the amount to retain in the business. Dividends do not accrue like interest on a note payable, and they are not a liability until declared.
The amount and timing of a dividend are important issues for management to consider. The payment of a large cash dividend could lead to liquidity problems for the company. On the other hand, a small dividend or a missed dividend may cause unhappiness among stockholders. Many stockholders expect to receive a reasonable cash payment from the company on a periodic basis. Many companies declare and pay cash dividends quarterly. On the other hand, a number of high-growth companies pay no dividends, preferring to conserve cash to finance future capital expenditures.
ENTRIES FOR CASH DIVIDENDS
Three dates are important in connection with dividends: (1) the declaration date, (2) the record date, and (3) the payment date. Normally, there are two to four weeks between each date. Companies make accounting entries on the declaration date and the payment date.
On the declaration date, the board of directors formally declares (authorizes) the cash dividend and announces it to stockholders. The declaration of a cash dividend commits the corporation to a legal obligation. The company must make an entry to recognize the increase in Cash Dividends and the increase in the liability Dividends Payable.
To illustrate, assume that on December 1, 2014, the directors of Media General declare a 50 cents per share cash dividend on 100,000 shares of $10 par value common stock. The dividend is $50,000 (100,000 × $0.50). The entry to record the declaration is:
Media General debits the account Cash Dividends. Cash dividends decrease retained earnings. We use the specific title Cash Dividends to differentiate it from other types of dividends, such as stock dividends. Dividends Payable is a current liability. It will normally be paid within the next several months. When using a Cash Dividends account, the company transfers the balance of that account to Retained Earnings at the end of the year by a closing entry. For homework problems, you should use the Cash Dividends account for recording dividend declarations.
At the record date, the company determines ownership of the outstanding shares for dividend purposes. The stockholders’ records maintained by the corporation supply this information. In the interval between the declaration date and the record date, the corporation updates its stock ownership records. For Media General, the record date is December 22. No entry is required on this date because the corporation's liability recognized on the declaration date is unchanged.
On the payment date, the company makes cash dividend payments to the stockholders of record (as of December 22) and records the payment of the dividend. If January 20 is the payment date for Media General, the entry on that date is:
Note that payment of the dividend reduces both current assets and current liabilities. It has no effect on stockholders’ equity. The cumulative effect of the declaration and payment of a cash dividend is to decrease both stockholders’ equity and total assets. Illustration 14-1 (page 652) summarizes the three important dates associated with dividends for Media General.
Helpful Hint The purpose of the record date is to identify the persons or entities that will receive the dividend, not to determine the amount of the dividend liability.
Illustration 14-1 Key dividend dates
ALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON STOCK
As explained in Chapter 13, preferred stock has priority over common stock in regard to dividends. Holders of cumulative preferred stock must be paid any unpaid prior-year dividends and their current year's dividend before common stockholders receive dividends.
To illustrate, assume that at December 31, 2014, IBR Inc. has 1,000 shares of 8%, $100 par value cumulative preferred stock. It also has 50,000 shares of $10 par value common stock outstanding. The dividend per share for preferred stock is $8 ($100 par value × 8%). The required annual dividend for preferred stock is therefore $8,000 (1,000 shares × $8). At December 31, 2014, the directors declare a $6,000 cash dividend. In this case, the entire dividend amount goes to preferred stockholders because of their dividend preference. The entry to record the declaration of the dividend is:
Because of the cumulative feature, dividends of $2 ($8 − $6) per share are in arrears on preferred stock for 2014. IBR must pay these dividends to preferred stockholders before it can pay any future dividends to common stockholders. IBR should disclose dividends in arrears in the financial statements.
At December 31, 2015, IBR declares a $50,000 cash dividend. The allocation of the dividend to the two classes of stock is as follows.
Illustration 14-2 Allocating dividends to preferred and common stock
The entry to record the declaration of the dividend is:
If IBR's preferred stock is not cumulative, preferred stockholders receive only $8,000 in dividends in 2015. Common stockholders receive $42,000.
ACCOUNTING ACROSS THE ORGANIZATION 
Up, Down, and ??
The decision whether to pay a dividend, and how much to pay, is a very important management decision. As the chart below shows, from 2002 to 2007, many companies substantially increased their dividends. Total dividends paid by U.S. companies hit record levels. One reason for the increase is that Congress lowered, from 39% to 15%, the tax rate paid by investors on dividends received, making dividends more attractive to investors.
Then the financial crisis of 2008 occurred. As result, in 2009, 804 companies cut their dividends (see chart) at the highest rate since the S&P started collecting data in 1995. In 2010, more companies started increasing their dividends. However, potential higher taxes on dividends in the future and the possibility of a low-growth economy may stall any significant increase.
Source: Matt Phillips and Jay Miller, “Last Year's Dividend Slash Was $58 Billion,” Wall Street Journal (January 8, 2010), p. C5.
What factors must management consider in deciding how large a dividend to pay? (See page 681.)
DO IT!
Dividends on Preferred and Common Stock
MasterMind Corporation has 2,000 shares of 6%, $100 par value preferred stock outstanding at December 31, 2014. At December 31, 2014, the company declared a $60,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios.
1. The preferred stock is noncumulative, and the company has not missed any dividends in previous years.
2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years.
3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years.
Determine dividends on preferred shares by multiplying the dividend rate times the par value of the stock times the number of preferred shares.
Understand the cumulative feature. If preferred stock is cumulative, then any missed dividends (dividends in arrears) and the current year's dividend must be paid to preferred stockholders before dividends are paid to common stockholders.
Solution
1. The company has not missed past dividends and the preferred stock is noncumulative. Thus, the preferred stockholders are paid only this year's dividend. The dividend paid to preferred stockholders would be $12,000 (2,000 × .06 × $100). The dividend paid to common stockholders would be $48,000 ($60,000 − $12,000).
2. The preferred stock is noncumulative. Thus, past unpaid dividends do not have to be paid. The dividend paid to preferred stockholders would be $12,000 (2,000 × .06 × $100). The dividend paid to common stockholders would be $48,000 ($60,000 − $12,000).
3. The preferred stock is cumulative. Thus, dividends that have been missed (dividends in arrears) must be paid. The dividend paid to preferred stockholders would be $36,000 (3 × 2,000 × .06 × $100). The dividend paid to common stockholders would be $24,000 ($60,000 − $36,000).
Related exercise material: E14-2 and DO IT!14-1.
Stock Dividends
A stock dividend is a pro rata (proportional to ownership) distribution of the corporation's own stock to stockholders. Whereas a company pays cash in a cash dividend, a company issues shares of stock in a stock dividend. A stock dividend results in a decrease in retained earnings and an increase in paid-in capital. Unlike a cash dividend, a stock dividend does not decrease total stockholders’ equity or total assets.
To illustrate, assume that you have a 2% ownership interest in Cetus Inc. That is, you own 20 of its 1,000 shares of common stock. If Cetus declares a 10% stock dividend, it would issue 100 shares (1,000 × 10%) of stock. You would receive two shares (2% × 100). Would your ownership interest change? No, it would remain at 2% (22 ÷ 1,100). You now own more shares of stock, but your ownership interest has not changed.
Cetus has disbursed no cash and has assumed no liabilities. What, then, are the purposes and benefits of a stock dividend? Corporations issue stock dividends generally for one or more of the following reasons.
1. To satisfy stockholders’ dividend expectations without spending cash.
2. To increase the marketability of the corporation's stock. When the number of shares outstanding increases, the market price per share decreases. Decreasing the market price of the stock makes it easier for smaller investors to purchase the shares.
3. To emphasize that a company has permanently reinvested in the business a portion of stockholders’ equity, which therefore is unavailable for cash dividends.
When the dividend is declared, the board of directors determines the size of the stock dividend and the value assigned to each dividend.
Generally, if the company issues a small stock dividend (less than 20–25% of the corporation's issued stock), the value assigned to the dividend is the fair value per share. This treatment is based on the assumption that a small stock dividend will have little effect on the market price of the shares previously outstanding. Thus, many stockholders consider small stock dividends to be distributions of earnings equal to the market price of the shares distributed. If a company issues a large stock dividend (greater than 20–25%), the price assigned to the dividend is the par or stated value. Small stock dividends predominate in practice. Thus, we will illustrate only entries for small stock dividends.
ENTRIES FOR STOCK DIVIDENDS
To illustrate the accounting for small stock dividends, assume that Medland Corporation has a balance of $300,000 in retained earnings. It declares a 10% stock dividend on its 50,000 shares of $10 par value common stock. The current market price of its stock is $15 per share. The number of shares to be issued is 5,000 (10% × 50,000). Therefore, the total amount to be debited to Stock Dividends is $75,000 (5,000 × $15). The entry to record the declaration of the stock dividend is as follows.
Medland debits Stock Dividends for the market price of the stock issued ($15 × 5,000). (Similar to Cash Dividends, Stock Dividends decrease retained earnings.) Medland also credits Common Stock Dividends Distributable for the par value of the dividend shares ($10 × 5,000) and credits Paid-in Capital in Excess of Par—Common Stock for the excess of the market price over par ($5 × 5,000).
Common Stock Dividends Distributable is a stockholders’ equity account. It is not a liability because assets will not be used to pay the dividend. If the company prepares a balance sheet before it issues the dividend shares, it reports the distributable account under paid-in capital as shown in Illustration 14-3.
Illustration 14-3 Statement presentation of common stock dividends distributable
When Medland issues the dividend shares, it debits Common Stock Dividends Distributable and credits Common Stock, as follows.
EFFECTS OF STOCK DIVIDENDS
How do stock dividends affect stockholders’ equity? They change the composition of stockholders’ equity because they transfer to paid-in capital a portion of retained earnings. However, total stockholders’ equity remains the same. Stock dividends also have no effect on the par or stated value per share. But the number of shares outstanding increases. Illustration 14-4 shows these effects for Medland Corporation.
Illustration 14-4 Stock dividend effects
In this example, total paid-in capital increases by $75,000 (50,000 shares × 10% × $15) and retained earnings decreases by the same amount. Note also that total stockholders’ equity remains unchanged at $800,000. The number of shares increases by 5,000 (50,000 × 10%).
Stock Splits
A stock split, like a stock dividend, involves issuance of additional shares to stockholders according to their percentage ownership. However, a stock split results in a reduction in the par or stated value per share. The purpose of a stock split is to increase the marketability of the stock by lowering its market price per share. This, in turn, makes it easier for the corporation to issue additional stock.
The effect of a split on market price is generally inversely proportional to the size of the split. For example, after a 2-for-1 stock split, the market price of Nike's stock fell from $111 to approximately $55. The lower market price stimulated market activity. Within one year, the stock was trading above $100 again. Illustration 14-5 shows the effect of a 4-for-1 stock split for stockholders.
Helpful Hint A stock split changes the par value per share but does not affect any balances in stockholders’ equity.
Illustration 14-5 Effect of stock split for stockholders
In a stock split, the number of shares increases in the same proportion that par or stated value per share decreases. For example, in a 2-for-1 split, one share of $10 par value stock is exchanged for two shares of $5 par value stock. A stock split does not have any effect on total paid-in capital, retained earnings, or total stockholders’ equity. But, the number of shares outstanding increases, and par value per share decreases. Illustration 14-6 shows these effects for Medland Corporation, assuming that it splits its 50,000 shares of common stock on a 2-for-1 basis.
Illustration 14-6 Stock split effects
A stock split does not affect the balances in any stockholders’ equity accounts. Therefore, it is not necessary to journalize a stock split.
Illustration 14-7 summarizes the differences between stock splits and stock dividends.
Illustration 14-7 Differences between the effects of stock splits and stock dividends
INVESTOR INSIGHT 
A No-Split Philosophy
Warren Buffett's company, Berkshire Hathaway, has two classes of shares. Until recently, the company had never split either class of stock. As a result, the class A stock had a market price of $97,000 and the class B sold for about $3,200 per share. Because the price per share is so high, the stock does not trade as frequently as the stock of other companies. Buffett has always opposed stock splits because he feels that a lower stock price attracts short-term investors. He appears to be correct. For example, while more than 6 million shares of IBM are exchanged on the average day, only about 1,000 class A shares of Berkshire are traded. Despite Buffett's aversion to splits, in order to accomplish a recent acquisition, Berkshire decided to split its class B shares 50 to 1.
Source: Scott Patterson, “Berkshire Nears Smaller Baby B's,” Wall Street Journal Online (January 19, 2010).
Why does Warren Buffett usually oppose stock splits? (See page 681.)
DO IT!
Stock Dividends and Stock Splits
Sing CD Company has had five years of record earnings. Due to this success, the market price of its 500,000 shares of $2 par value common stock has tripled from $15 per share to $45. During this period, paid-in capital remained the same at $2,000,000. Retained earnings increased from $1,500,000 to $10,000,000. President Joan Elbert is considering either a 10% stock dividend or a 2-for-1 stock split. She asks you to show the before-and-after effects of each option on retained earnings and total stockholders’ equity.
Action Plan
Calculate the stock dividend's effect on retained earnings by multiplying the number of new shares times the market price of the stock (or par value for a large stock dividend).
Recall that a stock dividend increases the number of shares without affecting total stockholders’ equity.
Recall that a stock split only increases the number of shares outstanding and decreases the par value per share.
Solution
Sing CD Company has had five years of record earnings. Due to this success, the market price of its 500,000 shares of $2 par value common stock has tripled from $15 per share to $45. During this period, paid-in capital remained the same at $2,000,000. Retained earnings increased from $1,500,000 to $10,000,000. President Joan Elbert is considering either a 10% stock dividend or a 2-for-1 stock split. She asks you to show the before-and-after effects of each option on retained earnings and total stockholders’ equity.
Related exercise material: BE14-3, E14-3, E14-4, E14-5, E14-6, E14-7, and DO IT! 14-2.
Retained Earnings
As you learned in Chapter 13, retained earnings is net income that a company retains in the business. The balance in retained earnings is part of the stockholders’ claim on the total assets of the corporation. It does not, though, represent a claim on any specific asset. Nor can the amount of retained earnings be associated with the balance of any asset account. For example, a $100,000 balance in retained earnings does not mean that there should be $100,000 in cash. The reason is that the company may have used the cash resulting from the excess of revenues over expenses to purchase buildings, equipment, and other assets.
To demonstrate that retained earnings and cash may be quite different, Illustration 14-8 shows recent amounts of retained earnings and cash in selected companies.
Illustration 14-8 Retained earnings and cash balances
Remember from Chapter 13 that when a company has net income, it closes net income to retained earnings. The closing entry is a debit to Income Summary and a credit to Retained Earnings.
When a company has a net loss (expenses exceed revenues), it also closes this amount to retained earnings. The closing entry in this case is a debit to Retained Earnings and a credit to Income Summary. This is done even if it results in a debit balance in Retained Earnings. Companies do not debit net losses to paid-in capital accounts. To do so would destroy the distinction between paid-in and earned capital. If cumulative losses exceed cumulative income over a company's life, a debit balance in Retained Earnings results. A debit balance in Retained Earnings is identified as a deficit. A company reports a deficit as a deduction in the stockholders’ equity section, as shown in Illustration 14-9.
Helpful Hint Remember that Retained Earnings is a stockholders’ equity account, whose normal balance is a credit.
Illustration 14-9 Stockholders’ equity with deficit
Retained Earnings Restrictions
The balance in retained earnings is generally available for dividend declarations. Some companies state this fact. For example, Lockheed Martin Corporation states the following in the notes to its financial statements.
Illustration 14-10 Disclosure of unrestricted retained earnings
In some cases, there may be retained earnings restrictions. These make a portion of the retained earnings balance currently unavailable for dividends. Restrictions result from one or more of the following causes.
1. Legal restrictions. Many states require a corporation to restrict retained earnings for the cost of treasury stock purchased. The restriction keeps intact the corporation's legal capital that is being temporarily held as treasury stock. When the company sells the treasury stock, the restriction is lifted.
2. Contractual restrictions. Long-term debt contracts may restrict retained earnings as a condition for the loan. The restriction limits the use of corporate assets for payment of dividends. Thus, it increases the likelihood that the corporation will be able to meet required loan payments.
3. Voluntary restrictions. The board of directors may voluntarily create retained earnings restrictions for specific purposes. For example, the board may authorize a restriction for future plant expansion. By reducing the amount of retained earnings available for dividends, the company makes more cash available for the planned expansion.
Companies generally disclose retained earnings restrictions in the notes to the financial statements. For example, as shown in Illustration 14-11, Tektronix Inc., a manufacturer of electronic measurement devices, had total retained earnings of $774 million, but the unrestricted portion was only $223.8 million.
Illustration 14-11 Disclosure of restriction
Prior Period Adjustments
Suppose that a corporation has closed its books and issued financial statements. The corporation then discovers that it made a material error in reporting net income of a prior year. How should the company record this situation in the accounts and report it in the financial statements?
The correction of an error in previously issued financial statements is known as a prior period adjustment. The company makes the correction directly to Retained Earnings because the effect of the error is now in this account. The net income for the prior period has been recorded in retained earnings through the journalizing and posting of closing entries.
To illustrate, assume that General Microwave discovers in 2014 that it understated depreciation expense on equipment in 2013 by $300,000 due to computational errors. These errors overstated both net income for 2013 and the current balance in retained earnings. The entry for the prior period adjustment, ignoring all tax effects, is as follows.
A debit to an income statement account in 2014 is incorrect because the error pertains to a prior year.
Companies report prior period adjustments in the retained earnings statement.1 They add (or deduct, as the case may be) these adjustments from the beginning retained earnings balance. This results in an adjusted beginning balance. For example, assuming a beginning balance of $800,000 in retained earnings, General Microwave reports the prior period adjustment as follows.
Illustration 14-12 Statement presentation of prior period adjustments
Again, reporting the correction in the current year's income statement would be incorrect because it applies to a prior year's income statement.
Retained Earnings Statement
The retained earnings statement shows the changes in retained earnings during the year. The company prepares the statement from the Retained Earnings account. Illustration 14-13 shows (in T-account form) transactions that affect retained earnings.
Illustration 14-13 Debits and credits to retained earnings
As indicated, net income increases retained earnings, and a net loss decreases retained earnings. Prior period adjustments may either increase or decrease retained earnings. Both cash dividends and stock dividends decrease retained earnings. The circumstances under which treasury stock transactions decrease retained earnings are explained in Chapter 13, page 623.
A complete retained earnings statement for Graber Inc., based on assumed data, is as follows.
Illustration 14-14 Retained earnings statement
DO IT!
Retained Earnings Statement
Vega Corporation has retained earnings of $5,130,000 on January 1, 2014. During the year, Vega earned $2,000,000 of net income. It declared and paid a $250,000 cash dividend. In 2014, Vega recorded an adjustment of $180,000 due to the understatement (from a mathematical error) of 2013 depreciation expense. Prepare a retained earnings statement for 2014.
Action Plan
Recall that a retained earnings statement begins with retained earnings, as reported at the end of the previous year.
Add or subtract any prior period adjustments to arrive at the adjusted beginning figure.
Add net income and subtract dividends declared to arrive at the ending balance in retained earnings.
Solution
Related exercise material: BE14-4, BE14-5, E14-8, E14-9, and DO IT! 14-3.
Statement Presentation and Analysis
Presentation
Illustration 14-15 (page 662) presents the stockholders’ equity section of Graber Inc.'s balance sheet. Note the following. (1) “Common stock dividends distributable” is shown under “Capital stock,” in “Paid-in capital.” (2) A note (Note R) discloses a retained earnings restriction.
Illustration 14-15 Comprehensive stockholders’ equity section
Instead of presenting a detailed stockholders’ equity section in the balance sheet and a retained earnings statement, many companies prepare a stockholders’ equity statement. This statement shows the changes (1) in each stockholders’ equity account and (2) in total that occurred during the year. An example of a stockholders’ equity statement appears in Apple's financial statements in Appendix A.
Analysis
Investors and analysts can measure profitability from the viewpoint of the common stockholder by the return on common stockholders’ equity. This ratio, as shown in Illustration 14-16, indicates how many dollars of net income the company earned for each dollar invested by the common stockholders. It is computed by dividing net income available to common stockholders (which is net income minus preferred stock dividends) by average common stockholders’ equity.
To illustrate, Walt Disney Company's beginning-of-the-year and end-of-the-year common stockholders’ equity were $31,820 and $30,753 million, respectively. Its net income was $4,687 million, and no preferred stock was outstanding. The return on common stockholders’ equity is computed as follows.
Illustration 14-16 Return on common stockholders’ equity and computation
As shown on page 662, if a company has preferred stock, we would deduct the amount of preferred dividends from the company's net income to compute income available to common stockholders. Also, the par value of preferred stock is deducted from total stockholders’ equity when computing the average common stockholders’ equity.
Income Statement Presentation
Income statements for corporations are the same as the statements for proprietorships or partnerships except for one thing: the reporting of income taxes. For income tax purposes, corporations are a separate legal entity. As a result, corporations report income tax expense in a separate section of the corporation income statement, before net income. The condensed income statement for Leads Inc. in Illustration 14-17 shows a typical presentation. Note that the corporation reports income before income taxes as one line item and income tax expense as another.
Illustration 14-17 Income statement with income taxes
Companies record income tax expense and the related liability for income taxes payable as part of the adjusting process. Using the data for Leads Inc., in Illustration 14-17, the adjusting entry for income tax expense at December 31, 2014, is:
The income statement of Apple (in Appendix A) presents another illustration of income taxes.
Income Statement Analysis
The financial press frequently reports earnings data. Stockholders and potential investors widely use these data in evaluating the profitability of a company. A convenient measure of earnings is earnings per share (EPS), which indicates the net income earned by each share of outstanding common stock.
EPS AND PREFERRED DIVIDENDS
The existence of preferred dividends slightly complicates the calculation of EPS. When a corporation has both preferred and common stock, we must subtract the current year's preferred dividend from net income, to arrive at income available to common stockholders. Illustration 14-18 shows the formula for computing EPS.
Illustration 14-18 Formula for earnings per share
Ethics Note
In order to meet market expectations for EPS, some managers engage in elaborate treasury stock transactions. These transactions can be very costly for the remaining shareholders.
To illustrate, assume that Rally Inc. reports net income of $211,000 on its 102,500 weighted-average common shares.2 During the year, it also declares a $6,000 dividend on its preferred stock. Therefore, the amount Rally has available for common stock dividends is $205,000 ($211,000 − $6,000). Earnings per share is $2 ($205,000 ÷ 102,500). If the preferred stock is cumulative, Rally deducts the dividend for the current year, whether or not it is declared. Remember that companies report earnings per share only for common stock.
Investors often attempt to link earnings per share to the market price per share of a company's stock.3 Because of the importance of earnings per share, most companies must report it on the face of the income statement. Generally, companies simply report this amount below net income on the statement. For Rally Inc., the presentation is as follows.
Illustration 14-19 Basic earnings per share disclosure
DO IT!
Stockholder's Equity and EPS
On January 1, 2014, Siena Corporation purchased 2,000 shares of treasury stock. Other information regarding Siena Corporation is provided below.
Compute (a) return on common stockholders’ equity for each year and (b) earnings per share for each year, and (c) discuss the changes in each.
Determine return on common stockholders’ equity by dividing net income available to common stockholders by the average common stockholders’ equity.
Determine earnings per share by dividing net income available to common stockholders by the weighted-average number of common shares outstanding.
Solution
Related exercise material: BE14-6, BE14-7, BE14-9, BE14-10, E14-12, E14-13, E14-14, E14-15, E14-16, E14-17, and DO IT! 14-4.
Instructions
(a) Journalize the transactions and the closing entry for net income.
(b) Prepare a stockholders’ equity section at December 31.
Solution to Comprehensive DO IT!
Action Plan
Award dividends to outstanding shares only.
Adjust the par value and number of shares for stock splits but make no journal entry.
Use market price of stock to determine the value of a small stock dividend.
Close Income Summary to Retained Earnings.
SUMMARY OF LEARNING OBJECTIVES
1 Prepare the entries for cash dividends and stock dividends. Companies make entries for both cash and stock dividends at the declaration date and at the payment date. At the declaration date, the entries are: cash dividend—debit Cash Dividends and credit Dividends Payable; small stock dividend—debit Stock Dividends, credit Paid-in Capital in Excess of Par (or Stated Value)—Common Stock, and credit Common Stock Dividends Distributable. At the payment date, the entries for cash and stock dividends are: cash dividend—debit Dividends Payable and credit Cash; small stock dividend—debit Common Stock Dividends Distributable and credit Common Stock.
2 Identify the items reported in a retained earnings statement. Companies report each of the individual debits and credits to retained earnings in the retained earnings statement. Additions consist of net income and prior period adjustments to correct understatements of prior years’ net income. Deductions consist of net loss, adjustments to correct overstatements of prior years’ net income, cash and stock dividends, and some disposals of treasury stock.
3 Prepare and analyze a comprehensive stockholders’ equity section. A comprehensive stockholders’ equity section includes all stockholders’ equity accounts. It consists of two sections: paid-in capital and retained earnings. It should also include notes to the financial statements that explain any restrictions on retained earnings and any dividends in arrears. One measure of profitability is the return on common stockholders’ equity. It is calculated by dividing net income minus preferred stock dividends by average common stockholders’ equity.
4 Describe the form and content of corporation income statements. The form and content of corporation income statements are similar to the statements of proprietorships and partnerships with one exception: Corporations must report income taxes or income tax expense in a separate section before net income in the income statement.
5 Compute earnings per share. Companies compute earnings per share by dividing net income by the weighted-average number of common shares outstanding during the period. When preferred stock dividends exist, they must be deducted from net income in order to calculate EPS.
GLOSSARY
Cash dividend A pro rata distribution of cash to stockholders. (p. 650).
Declaration date The date the board of directors formally declares (authorizes) a dividend and announces it to stockholders. (p. 651).
Deficit A debit balance in retained earnings. (p. 658).
Dividend A corporation's distribution of cash or stock to its stockholders on a pro rata (proportional) basis. (p. 650).
Earnings per share The net income earned by each share of outstanding common stock. (p. 663).
Liquidating dividend A dividend declared out of paid-in capital. (p. 650).
Payment date The date dividend checks are mailed to stockholders. (p. 651).
Prior period adjustment The correction of an error in previously issued financial statements. (p. 659).
Record date The date when ownership of outstanding shares is determined for dividend purposes. (p. 651).
Retained earnings Net income that a company retains in the business. (p. 658).
Retained earnings restrictions Circumstances that make a portion of retained earnings currently unavailable for dividends. (p. 659).
Retained earnings statement A financial statement that shows the changes in retained earnings during the year. (p. 660).
Return on common stockholders’ equity A measure of profitability that shows how many dollars of net income were earned for each dollar invested by the owners; computed as net income minus preferred dividends divided by average common stockholders’ equity. (p. 662).
Stock dividend A pro rata distribution to stockholders of the corporation's own stock. (p. 654).
Stockholders’ equity statement A statement that shows the changes in each stockholders’ equity account and in total stockholders’ equity during the year. (p. 662).
Stock split The issuance of additional shares of stock to stockholders according to their percentage ownership. It is accompanied by a reduction in the par or stated value per share. (p. 656).
Self-Test, Brief Exercises, Exercises, Problem Set A, and many more components are available for practice in WileyPLUS.
SELF-TEST QUESTIONS
Answers are on page 681.
(LO 1)
1. Entries for cash dividends are required on the:
(a) declaration date and the payment date.
(b) record date and the payment date.
(c) declaration date, record date, and payment date.
(d) declaration date and the record date.
(LO 1)
2. Which of the following statements about small stock dividends is true?
(a) A debit to Retained Earnings for the par value of the shares issued should be made.
(b) A small stock dividend decreases total stockholders’ equity.
(c) Market price per share should be assigned to the dividend shares.
(d) A small stock dividend ordinarily will have an effect on par value per share of stock.
(LO 1)
3. Which of the following statements about a 3-for-1 stock split is true?
(a) It will triple the market price of the stock.
(b) It will triple the amount of total stockholders’ equity.
(c) It will have no effect on total stockholders’ equity.
(d) It requires the company to distribute cash.
(LO 1)
4. Encore Inc. declared an $80,000 cash dividend. It currently has 3,000 shares of 7%, $100 par value cumulative preferred stock outstanding. It is one year in arrears on its preferred stock. How much cash will Encore distribute to the common stockholders?
(a) $38,000.
(b) $42,000.
(c) $59,000.
(d) None.
(LO 1)
5. Raptor Inc. has retained earnings of $500,000 and total stockholders’ equity of $2,000,000. It has 100,000 shares of $8 par value common stock outstanding, which is currently selling for $30 per share. If Raptor declares a 10% stock dividend on its common stock:
(a) net income will decrease by $80,000.
(b) retained earnings will decrease by $80,000 and total stockholders’ equity will increase by $80,000.
(c) retained earnings will decrease by $300,000 and total stockholders’ equity will increase by $300,000.
(d) retained earnings will decrease by $300,000 and total paid-in capital will increase by $300,000.
(LO 2)
6. Which of the following can cause a restriction in retained earnings?
(a) State laws regarding treasury stock.
(b) Long-term debt contract terms.
(c) Authorizations by the board of directors in light of planned expansion of corporate facilities.
(d) All of the above.
(LO 2)
7. All but one of the following is reported in a retained earnings statement. The exception is:
(a) cash and stock dividends.
(b) net income and net loss.
(c) sales revenue.
(d) prior period adjustments.
(LO 2)
8. A prior period adjustment is:
(a) reported in the income statement as a nontypical item.
(b) a correction of an error that is recorded directly to retained earnings.
(c) reported directly in the stockholders’ equity section.
(d) reported in the retained earnings statement as an adjustment of the ending balance of retained earnings.
(LO 3)
9. In the stockholders’ equity section, Common Stock Dividends Distributable is reported as a(n):
(a) deduction from total paid-in capital and retained earnings.
(b) addition to additional paid-in capital.
(c) deduction from retained earnings.
(d) addition to capital stock.
(LO 3)
10. Katie Inc. reported net income of $186,000 during 2014 and paid dividends of $26,000 on common stock. It also has 10,000 shares of 6%, $100 par value, non-cumulative preferred stock outstanding and paid dividends of $60,000 on preferred stock. Common stockholders’ equity was $1,200,000 on January 1, 2014, and $1,600,000 on December 31, 2014. The company's return on common stockholders’ equity for 2014 is:
(a) 10.0%.
(b) 9.0%.
(c) 7.1%.
(d) 13.3%.
(LO 3)
11. The return on common stockholders’ equity is defined as:
(a) net income divided by total assets.
(b) cash dividends divided by average common stockholders’ equity.
(c) income available to common stockholders divided by average common stockholders’ equity.
(d) None of these is correct.
(LO 4)
12. During 2014, Talon Inc. had sales revenue $376,000, gross profit $176,000, operating expenses $66,000, cash dividends $30,000, other expenses and losses $20,000. Its corporate tax rate is 30%. What was Talon's income tax expense for the year?
(a) $18,000.
(b) $52,800.
(c) $112,800.
(d) $27,000.
(LO 4)
13. Corporation income statements may be the same as the income statements for unincorporated companies except for:
(a) gross profit.
(b) income tax expense.
(c) operating income.
(d) net sales.
(LO 5)
14. If everything else is held constant, earnings per share is increased by:
(a) the payment of a cash dividend to common shareholders.
(b) the payment of a cash dividend to preferred shareholders.
(c) the issuance of new shares of common stock.
(d) the purchase of treasury stock.
(LO 5)
15. The income statement for Nadeen, Inc. shows income before income taxes $700,000, income tax expense $210,000, and net income $490,000. If Nadeen has 100,000 shares of common stock outstanding throughout the year, earnings per share is:
(a) $7.00.
(b) $4.90.
(c) $2.10.
(d) No correct answer is given.
Go to the book's companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.
QUESTIONS
1. (a) What is a dividend? (b) “Dividends must be paid in cash.” Do you agree? Explain.
2. Jan Kimler maintains that adequate cash is the only requirement for the declaration of a cash dividend. Is Jan correct? Explain.
3. (a) Three dates are important in connection with cash dividends. Identify these dates, and explain their significance to the corporation and its stockholders.
(b) Identify the accounting entries that are made for a cash dividend and the date of each entry.
4. Farley Inc. declares a $55,000 cash dividend on December 31, 2014. The required annual dividend on preferred stock is $10,000. Determine the allocation of the dividend to preferred and common stockholders assuming the preferred stock is cumulative and dividends are 1 year in arrears.
5. Contrast the effects of a cash dividend and a stock dividend on a corporation's balance sheet.
6. Rich Mordica asks, “Since stock dividends don't change anything, why declare them?” What is your answer to Rich?
7. Gorton Corporation has 30,000 shares of $10 par value common stock outstanding when it announces a 2-for-1 stock split. Before the split, the stock had a market price of $120 per share. After the split, how many shares of stock will be outstanding? What will be the approximate market price per share?
8. The board of directors is considering either a stock split or a stock dividend. They understand that total stockholders’ equity will remain the same under either action. However, they are not sure of the different effects of the two types of actions on other aspects of stockholders’ equity. Explain the differences to the directors.
9. What is a prior period adjustment, and how is it reported in the financial statements?
10. NAJ Corporation has a retained earnings balance of $230,000 on January 1. During the year, a prior period adjustment of $50,000 is recorded because of the understatement of depreciation in the prior period. Show the retained earnings statement presentation of these data.
11. What is the purpose of a retained earnings restriction? Identify the possible causes of retained earnings restrictions.
12. How are retained earnings restrictions generally reported in the financial statements?
13. Identify the events that result in debits and credits to retained earnings.
14. Rafy Furcal believes that both the beginning and ending balances in retained earnings are shown in the stockholders’ equity section. Is Rafy correct? Discuss.
15. Dean Percival, who owns many investments in common stock, says, “I don't care what a company's net income is. The stock price tells me everything I need to know!” How do you respond to Dean?
16. What is the unique feature of a corporation income statement? Illustrate this feature, using assumed data.
17. Why must preferred stock dividends be subtracted from net income in computing earnings per share?
18. What were the amounts of basic earnings per share of common stock that Apple reported in the years 2007 to 2011?
BRIEF EXERCISES
Prepare entries for a cash dividend.
(LO 1)
BE14-1 Greenwood Corporation has 80,000 shares of common stock outstanding. It declares a $1 per share cash dividend on November 1 to stockholders of record on December 1. The dividend is paid on December 31. Prepare the entries on the appropriate dates to record the declaration and payment of the cash dividend.
Prepare entries for a stock dividend.
(LO 1)
BE14-2 Langley Corporation has 50,000 shares of $10 par value common stock outstanding. It declares a 15% stock dividend on December 1 when the market price per share is $16. The dividend shares are issued on December 31. Prepare the entries for the declaration and payment of the stock dividend.
Show before-and-after effects of a stock dividend.
(LO 1)
BE14-3 The stockholders’ equity section of Pretzer Corporation consists of common stock ($10 par) $2,000,000 and retained earnings $500,000. A 10% stock dividend (20,000 shares) is declared when the market price per share is $14. Show the before-and-after effects of the dividend on the following.
(a) The components of stockholders’ equity.
(b) Shares outstanding.
(c) Par value per share.
Prepare a retained earnings statement.
(LO 2)
BE14-4 For the year ending December 31, 2014, Soto Inc. reports net income $170,000 and dividends $85,000. Prepare the retained earnings statement for the year assuming the balance in retained earnings on January 1, 2014, was $220,000.
Prepare a retained earnings statement.
(LO 2)
BE14-5 The balance in retained earnings on January 1, 2014, for Palmer Inc. was $800,000. During the year, the corporation paid cash dividends of $90,000 and distributed a stock dividend of $8,000. In addition, the company determined that it had understated its depreciation expense in prior years by $50,000. Net income for 2014 was $120,000. Prepare the retained earnings statement for 2014.
Calculate the return on common stockholders’ equity.
(LO 3)
BE14-6 SUPERVALU, one of the largest grocery retailers in the United States, is headquartered in Minneapolis. Suppose the following financial information (in millions) was taken from the company's 2014 annual report: net sales $40,597, net income $393, beginning common stockholders’ equity $2,581, and ending common stockholders’ equity $2,887. Compute the return on common stockholders’ equity.
Compute the return on common stockholders’ equity.
(LO 3)
BE14-7 Whetzel Corporation reported net income of $152,000, declared dividends on common stock of $50,000, and had an ending balance in retained earnings of $360,000. Common stockholders’ equity was $700,000 at the beginning of the year and $820,000 at the end of the year. Compute the return on common stockholders’ equity.
Prepare a corporate income statement.
(LO 4)
BE14-8 The following information is available for Reinsch Corporation for the year ended December 31, 2014: cost of goods sold $205,000, sales revenue $350,000, other revenues and gains $50,000, and operating expenses $75,000. Assuming a corporate tax rate of 30%, prepare an income statement for the company.
Compute earnings per share.
(LO 5)
BE14-9 Ziegler Corporation reports net income of $380,000 and a weighted-average of 200,000 shares of common stock outstanding for the year. Compute the earnings per share of common stock.
Compute earnings per share with cumulative preferred stock.
(LO 5)
BE14-10 Income and common stock data for Ziegler Corporation are presented in BE14-9. Assume also that Ziegler has cumulative preferred stock dividends for the current year of $30,000 that were declared and paid. Compute the earnings per share of common stock.
DO IT! Review
Determine dividends paid to preferred and common stockholders.
(LO 1)
DO IT! 14-1 Herr Corporation has 3,000 shares of 7%, $100 par value preferred stock outstanding at December 31, 2014. At December 31, 2014, the company declared a $105,000 cash dividend. Determine the dividend paid to preferred stockholders and common stockholders under each of the following scenarios.
1. The preferred stock is noncumulative, and the company has not missed any dividends in previous years.
2. The preferred stock is noncumulative, and the company did not pay a dividend in each of the two previous years.
3. The preferred stock is cumulative, and the company did not pay a dividend in each of the two previous years.
Determine effects of stock dividend and stock split.(LO 1)
DO IT! 14-2 Jurgens Company has had÷years of net income. Due to this success, the market price of its 400,000 shares of $3 par value common stock has increased from $12 per share to $46. During this period, paid-in capital remained the same at $2,800,000. Retained earnings increased from $1,800,000 to $12,000,000. President E. Rife is considering either a 15% stock dividend or a 2-for-1 stock split. He asks you to show the before-and-after effects of each option on (a) retained earnings and (b) total stockholders’ equity.
Prepare a retained earnings statement.
(LO 2)
DO IT! 14-3 Foley Corporation has retained earnings of $3,100,000 on January 1, 2014. During the year, Foley earned $1,200,000 of net income. It declared and paid a $150,000 cash dividend. In 2014, Foley recorded an adjustment of $110,000 due to the overstatement (from mathematical error) of 2013 depreciation expense. Prepare a retained earnings statement for 2014.
Compute return on stockholders’ equity and EPS and discuss changes in each.
(LO 3, 5)
DO IT! 14-4 On January 1, 2014, Vahsholtz Corporation purchased 5,000 shares of treasury stock. Other information regarding Vahsholtz Corporation is provided on page 671.
Compute (a) return on common stockholders’ equity for each year and (b) earnings per share for each year, and (c) discuss the changes in each.
EXERCISES
E14-1 On January 1, Guillen Corporation had 95,000 shares of no-par common stock issued and outstanding. The stock has a stated value of $5 per share. During the year, the following occurred.
| Apr. 1 | Issued 25,000 additional shares of common stock for $17 per share. |
| June 15 | Declared a cash dividend of $1 per share to stockholders of record on June 30. |
| July 10 | Paid the $1 cash dividend. |
| Dec. 1 | Issued 2,000 additional shares of common stock for $19 per share. |
| 15 | Declared a cash dividend on outstanding shares of $1.20 per share to stockholders of record on December 31. |
Journalize cash dividends; indicate statement presentation.
(LO 1)
Instructions
(a) Prepare the entries, if any, on each of the three dividend dates.
(b) How are dividends and dividends payable reported in the financial statements prepared at December 31?
E14-2 Knudsen Corporation was organized on January 1, 2013. During its first year, the corporation issued 2,000 shares of $50 par value preferred stock and 100,000 shares of $10 par value common stock. At December 31, the company declared the following cash dividends: 2013, $5,000; 2014, $12,000; and 2015, $28,000.
Allocate cash dividends to preferred and common stock.
(LO 1)
Instructions
(a) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 6% and noncumulative.
(b) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 7% and cumulative.
(c) Journalize the declaration of the cash dividend at December 31, 2015, under part (b).
E14-3 On January 1, 2014, Frontier Corporation had $1,000,000 of common stock outstanding that was issued at par. It also had retained earnings of $750,000. The company issued 40,000 shares of common stock at par on July 1 and earned net income of $400,000 for the year.
Journalize stock dividends.
(LO 1)
Instructions
Journalize the declaration of a 15% stock dividend on December 10, 2014, for the following independent assumptions.
(a) Par value is $10, and market price is $18.
(b) Par value is $5, and market price is $20.
E14-4 On October 31, the stockholders’ equity section of Heins Company consists of common stock $500,000 and retained earnings $900,000. Heins is considering the following two courses of action: (1) declaring a 5% stock dividend on the 50,000, $10 par value shares outstanding, or (2) effecting a 2-for-1 stock split that will reduce par value to $5 per share. The current market price is $14 per share.
Compare effects of a stock dividend and a stock split.
(LO 1)
Instructions
Prepare a tabular summary of the effects of the alternative actions on the components of stockholders’ equity, outstanding shares, and par value per share. Use the following column headings: Before Action, After Stock Dividend, and After Stock Split.
Indicate account balances after a stock dividend.
(LO 1, 3)
E14-5 On October 1, Little Bobby Corporation's stockholders’ equity is as follows.
On October 1, Little Bobby declares and distributes a 10% stock dividend when the market price of the stock is $15 per share.
Instructions
(a) Compute the par value per share (1) before the stock dividend and (2) after the stock dividend.
(b) Indicate the balances in the three stockholders’ equity accounts after the stock dividend shares have been distributed.
Indicate the effects on stockholders’ equity components.
(LO 1, 2, 3)
E14-6 During 2014, Roblez Corporation had the following transactions and events.
1. Declared a cash dividend.
2. Issued par value common stock for cash at par value.
3. Completed a 2-for-1 stock split in which $10 par value stock was changed to $5 par value stock.
4. Declared a small stock dividend when the market price was higher than par value.
5. Made a prior period adjustment for overstatement of net income.
6. Issued the shares of common stock required by the stock dividend declaration in item no. 4 above.
7. Paid the cash dividend in item no. 1 above.
8. Issued par value common stock for cash above par value.
Instructions
Indicate the effect(s) of each of the foregoing items on the subdivisions of stockholders’ equity. Present your answer in tabular form with the following columns. Use (I) for increase, (D) for decrease, and (NE) for no effect. Item no. 1 is given as an example.
Prepare correcting entries for dividends and a stock split.
(LO 1)
E14-7 Before preparing financial statements for the current year, the chief accountant for Toso Company discovered the following errors in the accounts.
1. The declaration and payment of $50,000 cash dividend was recorded as a debit to Interest Expense $50,000 and a credit to Cash $50,000.
2. A 10% stock dividend (1,000 shares) was declared on the $10 par value stock when the market price per share was $18. The only entry made was Stock Dividends (Dr.) $10,000 and Dividend Payable (Cr.) $10,000. The shares have not been issued.
3. A 4-for-1 stock split involving the issue of 400,000 shares of $5 par value common stock for 100,000 shares of $20 par value common stock was recorded as a debit to Retained Earnings $2,000,000 and a credit to Common Stock $2,000,000.
Instructions
Prepare the correcting entries at December 31.
Prepare a retained earnings statement.
(LO 2)
E14-8 On January 1, 2014, Eddy Corporation had retained earnings of $650,000. During the year, Eddy had the following selected transactions.
1. Declared cash dividends $120,000.
2. Corrected overstatement of 2013 net income because of depreciation error $40,000.
3. Earned net income $350,000.
4. Declared stock dividends $90,000.
Instructions
Prepare a retained earnings statement for the year.
E14-9 Newland Company reported retained earnings at December 31, 2013, of $310,000. Newland had 200,000 shares of common stock outstanding at the beginning of 2014.
The following transactions occurred during 2014.
Prepare a retained earnings statement.
(LO 2)
1. An error was discovered. In 2012, depreciation expense was recorded at $70,000, but the correct amount was $50,000.
2. A cash dividend of $0.50 per share was declared and paid.
3. A 5% stock dividend was declared and distributed when the market price per share was $15 per share.
4. Net income was $285,000.
Instructions
Prepare a retained earnings statement for 2014.
E14-10 Dirk Company reported the following balances at December 31, 2013: common stock $500,000, paid-in capital in excess of par value—common stock $100,000, and retained earnings $250,000. During 2014, the following transactions affected stockholder's equity.
Prepare a stockholders’ equity section.
(LO 3)
1. Issued preferred stock with a par value of $125,000 for $200,000.
2. Purchased treasury stock (common) for $40,000.
3. Earned net income of $180,000.
4. Declared and paid cash dividends of $56,000.
Instructions
Prepare the stockholders’ equity section of Dirk Company's December 31, 2014, balance sheet.
E14-11 The following accounts appear in the ledger of Horner Inc. after the books are closed at December 31.
Prepare a stockholders’ equity section.
(LO 3)
Instructions
Prepare the stockholders’ equity section at December 31, assuming retained earnings is restricted for plant expansion in the amount of $100,000.
E14-12 The following information is available for Norman Corporation for the year ended December 31, 2014: sales revenue $700,000, other revenues and gains $92,000, operating expenses $110,000, cost of goods sold $465,000, other expenses and losses $32,000, and preferred stock dividends $30,000. The company's tax rate was 30%, and it had 50,000 shares outstanding during the entire year.
Prepare an income statement and compute earnings per share.
(LO 4, 5)
Instructions
(a) Prepare a corporate income statement.
(b) Calculate earnings per share.
E14-13 In 2014, Pennington Corporation had net sales of $600,000 and cost of goods sold of $360,000. Operating expenses were $153,000, and interest expense was $7,500. The corporation's tax rate is 30%. The corporation declared preferred dividends of $15,000 in 2014, and its average common stockholders’ equity during the year was $200,000.
Prepare an income statement and compute return on equity.
(LO 3, 4)
Instructions
(a) Prepare an income statement for Pennington Corporation.
(b) Compute Pennington Corporation's return on common stockholders’ equity for 2014.
E14-14 Ringgold Corporation has outstanding at December 31, 2014, 50,000 shares of $20 par value, cumulative, 6% preferred stock and 200,000 shares of $5 par value common stock. All shares were outstanding the entire year. During 2014, Ringgold earned total revenues of $2,000,000 and incurred total expenses (except income taxes) of $1,300,000. Ringgold's income tax rate is 30%.
Compute EPS.
(LO 4, 5)
Compute Ringgold's 2014 earnings per share.
Calculate ratios to evaluate earnings performance.
(LO 3, 5)
E14-15 The following financial information is available for Plummer Corporation.
The weighted-average number of shares of common stock outstanding was 80,000 for 2013 and 100,000 for 2014.
Instructions
Calculate earnings per share and return on common stockholders’ equity for 2014 and 2013.
Calculate ratios to evaluate earnings performance.
(LO 3, 5)
E14-16 This financial information is available for Klinger Corporation.
The weighted-average number of shares of common stock outstanding was 180,000 for 2013 and 150,000 for 2014.
Instructions
Calculate earnings per share and return on common stockholders’ equity for 2014 and 2013.
Compute earnings per share under different assumptions.
(LO 5)
E14-17 At December 31, 2014, Millwood Corporation has 2,000 shares of $100 par value, 8%, preferred stock outstanding and 100,000 shares of $10 par value common stock issued. Millwood's net income for the year is $241,000.
Instructions
Compute the earnings per share of common stock under the following independent situations. (Round to two decimals.)
(a) The dividend to preferred stockholders was declared. There has been no change in the number of shares of common stock outstanding during the year.
(b) The dividend to preferred stockholders was not declared. The preferred stock is cumulative. Millwood held 10,000 shares of common treasury stock throughout the year.
EXERCISES: SET B AND CHALLENGE EXERCISES
Visit the book's companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.
PROBLEMS: SET A
Prepare dividend entries and stockholders’ equity section.
(LO 1, 3)
P14-1A On January 1, 2014, Geffrey Corporation had the following stockholders’ equity accounts.
During the year, the following transactions occurred.
| Feb. | 1 | Declared a $1 cash dividend per share to stockholders of record on February 15, payable March 1. |
| Mar. | 1 | Paid the dividend declared in February. |
| Apr. | 1 | Announced a 2-for-1 stock split. Prior to the split, the market price per share was $36. |
| July | 1 | Declared a 10% stock dividend to stockholders of record on July 15, distributable July 31. On July 1, the market price of the stock was $13 per share. |
| 31 | Issued the shares for the stock dividend. | |
| Dec. | 1 | Declared a $0.50 per share dividend to stockholders of record on December 15, payable January 5, 2015. |
| 31 | Determined that net income for the year was $350,000. |
Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances, and post the entries to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.
(c) Total stockholders’ equity $2,224,000
P14-2A The stockholders’ equity accounts of Karp Company at January 1, 2014, are as follows.
Journalize and post transactions; prepare retained earnings statement and stockholders’ equity section.
(LO 1, 2, 3)
| Preferred Stock, 6%, $50 par | $600,000 |
| Common Stock, $5 par | 800,000 |
| Paid-in Capital in Excess of Par—Preferred Stock | 200,000 |
| Paid-in Capital in Excess of Par—Common Stock | 300,000 |
| Retained Earnings | 800,000 |
There were no dividends in arrears on preferred stock. During 2014, the company had the following transactions and events.
| July | 1 | Declared a $0.60 cash dividend per share on common stock. |
| Aug. | 1 | Discovered $25,000 understatement of 2013 depreciation on equipment. (Ignore income taxes.) |
| Sept. | 1 | Paid the cash dividend declared on July 1. |
| Dec. | 1 | Declared a 15% stock dividend on common stock when the market price of the stock was $18 per share. |
| 15 | Declared a 6% cash dividend on preferred stock payable January 15, 2015. | |
| 31 | Determined that net income for the year was $355,000. | |
| 31 | Recognized a $200,000 restriction of retained earnings for plant expansion. |
Instructions
(a) Journalize the transactions, events, and closing entries for net income and dividends.
(b) Enter the beginning balances in the accounts, and post to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a retained earnings statement for the year.
(d) Prepare a stockholders’ equity section at December 31, 2014.
(c) Ending balance $566,000
(d) Total stockholders’ equity $2,898,000
P14-3A The post-closing trial balance of Storey Corporation at December 31, 2014, contains the following stockholders’ equity accounts.
Prepare retained earnings statement and stockholders’ equity section, and compute allocation of dividends and earnings per share.(LO 1, 2, 3, 5)
| Preferred Stock (15,000 shares issued) | $ 750,000 |
| Common Stock (250,000 shares issued) | 2,500,000 |
| Paid-in Capital in Excess of Par–Preferred Stock | 250,000 |
| Paid-in Capital in Excess of Par–Common Stock | 400,000 |
| Common Stock Dividends Distributable | 250,000 |
| Retained Earnings | 1,042,000 |
A review of the accounting records reveals the following.
1. No errors have been made in recording 2014 transactions or in preparing the closing entry for net income.
2. Preferred stock is $50 par, 6%, and cumulative; 15,000 shares have been outstanding since January 1, 2013.
3. Authorized stock is 20,000 shares of preferred, 500,000 shares of common with a $10 par value.
4. The January 1 balance in Retained Earnings was $1,170,000.
5. On July 1, 20,000 shares of common stock were issued for cash at $16 per share.
6. On September 1, the company discovered an understatement error of $90,000 in computing depreciation in 2013. The net of tax effect of $63,000 was properly debited directly to Retained Earnings.
7. A cash dividend of $250,000 was declared and properly allocated to preferred and common stock on October 1. No dividends were paid to preferred stockholders in 2013.
8. On December 31, a 10% common stock dividend was declared out of retained earnings on common stock when the market price per share was $16.
9. Net income for the year was $585,000.
10. On December 31, 2014, the directors authorized disclosure of a $200,000 restriction of retained earnings for plant expansion. (Use Note X.)
Instructions
(a) Reproduce the Retained Earnings account (T-account) for 2014.
(b) Prepare a retained earnings statement for 2014.
(c) Prepare a stockholders’ equity section at December 31, 2014.
(d) Compute the allocation of the cash dividend to preferred and common stock.
(c) Total stockholders’ equity $5,192,000
P14-4A On January 1, 2014, Ven Corporation had the following stockholders’ equity accounts.
Prepare the stockholders’ equity section, reflecting dividends and stock split.
(LO 1, 2, 3)
| Common Stock (no par value, 90,000 shares issued and outstanding) | $1,600,000 |
| Retained Earnings | 500,000 |
During the year, the following transactions occurred.
| Feb. | 1 | Declared a $1 cash dividend per share to stockholders of record on February 15, payable March 1. |
| Mar. | 1 | Paid the dividend declared in February. |
| Apr. | 1 | Announced a 3-for-1 stock split. Prior to the split, the market price per share was $36. |
| July | 1 | Declared a 5% stock dividend to stockholders of record on July 15, distributable July 31. On July 1, the market price of the stock was $16 per share. |
| 31 | Issued the shares for the stock dividend. | |
| Dec. | 1 | Declared a $0.50 per share dividend to stockholders of record on December 15, payable January 5, 2015. |
| 31 | Determined that net income for the year was $350,000. |
Instructions
Prepare the stockholders’ equity section of the balance sheet at (a) March 31, (b) June 30, (c) September 30, and (d) December 31, 2014.
(d) Total stockholders’ equity $2,218,250
Prepare the stockholders’ equity section, reflecting various events.
(LO 1, 2, 3)
P14-5A On January 1, 2014, Shellenburger Inc. had the following stockholders’ equity account balances.
| Common Stock, no-par value (500,000 shares issued) | $1,500,000 |
| Common Stock Dividends Distributable | 200,000 |
| Retained Earnings | 600,000 |
During 2014, the following transactions and events occurred.
1. Issued 50,000 shares of common stock as a result of a 10% stock dividend declared on December 15, 2013.
2. Issued 30,000 shares of common stock for cash at $6 per share.
3. Corrected an error that had understated the net income for 2012 by $70,000.
4. Declared and paid a cash dividend of $80,000.
5. Earned net income of $300,000.
Total stockholders’ equity $2,770,000
Instructions
Prepare the stockholders’ equity section of the balance sheet at December 31, 2014.
PROBLEMS: SET B
P14-1B On January 1, 2014, Chen Corporation had the following stockholders’ equity accounts.
| Common Stock ($5 par value, 200,000 shares issued and outstanding) | $1,000,000 |
| Paid-in Capital in Excess of Par—Common Stock | 200,000 |
| Retained Earnings | 840,000 |
Prepare dividend entries and stockholders’ equity section.
(LO 1, 3)
During the year, the following transactions occurred.
| Jan. | 15 | Declared a $1 cash dividend per share to stockholders of record on January 31, payable February 15. |
| Feb. | 15 | Paid the dividend declared in January. |
| Apr. | 15 | Declared a 10% stock dividend to stockholders of record on April 30, distributable May 15 On April 15, the market price of the stock was $15 per share. |
| May | 15 | Issued the shares for the stock dividend. |
| July | 1 | Announced a 2-for-1 stock split. The market price per share prior to the announcement was $17. (The new par value is $2.50.) |
| Dec. | 1 | Declared a $0.50 per share cash dividend to stockholders of record on December 15, payable January 10, 2015. |
| 31 | Determined that net income for the year was $250,000. |
Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances, and post the entries to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a stockholders’ equity section at December 31.
(c) Total stockholders’ equity $1,870,000
P14-2B The stockholders’ equity accounts of Holt Inc., at January 1, 2014, are as follows.
Journalize and post transactions; prepare retained earnings statement and stockholders’ equity section.
(LO 1, 2, 3)
| Preferred Stock, $100 par, 7% | $600,000 |
| Common Stock, $10 par | 900,000 |
| Paid-in Capital in Excess of Par—Preferred Stock | 100,000 |
| Paid-in Capital in Excess of Par—Common Stock | 200,000 |
| Retained Earnings | 500,000 |
There were no dividends in arrears on preferred stock. During 2014, the company had the following transactions and events.
| July | 1 | Declared a $0.50 cash dividend per share on common stock. |
| Aug. | 1 | Discovered a $72,000 overstatement of 2013 depreciation on equipment. (Ignore income taxes.) |
| Sept. | 1 | Paid the cash dividend declared on July 1. |
| Dec. | 1 | Declared a 10% stock dividend on common stock when the market price of the stock was $16 per share. |
| 15 | Declared a 7% cash dividend on preferred stock payable January 31, 2015. | |
| 31 | Determined that net income for the year was $350,000. |
Instructions
(a) Journalize the transactions and the closing entries for net income and dividends.
(b) Enter the beginning balances in the accounts and post to the stockholders’ equity accounts. (Note: Open additional stockholders’ equity accounts as needed.)
(c) Prepare a retained earnings statement for the year.
(d) Prepare a stockholders’ equity section at December 31, 2014.
(c) Ending balance $691,000
(d) Total stockholders’ equity $2,635,000
P14-3B The ledger of Giffin Corporation at December 31, 2014, after the books have been closed, contains the following stockholders’ equity accounts.
| Preferred Stock (10,000 shares issued) | $1,000,000 |
| Common Stock (400,000 shares issued) | 2,000,000 |
| Paid-in Capital in Excess of Par—Preferred Stock | 200,000 |
| Paid-in Capital in Excess of Stated Value—Common Stock | 1,180,000 |
| Common Stock Dividends Distributable | 200,000 |
| Retained Earnings | 2,560,000 |
Prepare retained earnings statement and stockholders’ equity section, and compute allocation of dividends and earnings per share.
(LO 1, 2, 3, 5)
A review of the accounting records reveals the following.
1. No errors have been made in recording 2014 transactions or in preparing the closing entry for net income.
2. Preferred stock is 6%, $100 par value, noncumulative, and callable at $125. Since January 1, 2013, 10,000 shares have been outstanding; 20,000 shares are authorized.
3. Common stock is no-par with a stated value of $5 per share; 600,000 shares are authorized.
4. The January 1 balance in Retained Earnings was $2,450,000.
5. On October 1, 100,000 shares of common stock were sold for cash at $8 per share.
6. A cash dividend of $500,000 was declared and properly allocated to preferred and common stock on November 1. No dividends were paid to preferred stockholders in 2013.
7. On December 31, a 10% common stock dividend was declared out of retained earnings on common stock when the market price per share was $9.
8. Net income for the year was $970,000.
9. On December 31, 2014, the directors authorized disclosure of a $100,000 restriction of retained earnings for plant expansion. (Use Note A.)
Instructions
(a) Reproduce the Retained Earnings account (T-account) for 2014.
(b) Prepare a retained earnings statement for 2014.
(c) Prepare a stockholders’ equity section at December 31, 2014.
(d) Compute the allocation of the cash dividend to preferred and common stock.
(c) Total stockholders’ equity $7,140,000
P14-4B On January 1, 2014, Dingler Corporation had the following stockholders’ equity accounts.
| Common Stock (no-par value, 100,000 shares issued and outstanding) | $2,800,000 |
| Retained Earnings | 1,000,000 |
During the year, the following transactions occurred.
| Feb. | 1 | Declared a $1 cash dividend per share to stockholders of record on February 15, payable March 1. |
| Mar. | 1 | Paid the dividend declared in February. |
| Apr. | 1 | Announced a 4-for-1 stock split. Prior to the split, the market price per share was $36. |
| July | 1 | Declared a 5% stock dividend to stockholders of record on July 15, distributable July 31. On July 1, the market price of the stock was $13 per share. |
| 31 | Issued the shares for the stock dividend. | |
| Dec. | 1 | Declared a $0.50 per share dividend to stockholders of record on December 15, payable January 5, 2015. |
| 31 | Determined that net income for the year was $700,000. |
Prepare the stockholders’ equity section, reflecting dividends and stock split.
(LO 1, 2, 3)
Instructions
Prepare the stockholders’ equity section of the balance sheet at (a) March 31, (b) June 30, (c) September 30, and (d) December 31, 2014.
(d) Total, stockholders’ equity $4,190,000
P14-5B On January 1, 2014, Hammond Inc. had the following shareholders’ equity balances.
| Common Stock, no-par value (1,000,000 shares issued) | $3,000,000 |
| Common Stock Dividends Distributable | 400,000 |
| Retained Earnings | 1,200,000 |
Prepare the stockholders’ equity section, reflecting various events.
(LO 1, 2, 3)
During 2014, the following transactions and events occurred.
1. Issued 100,000 shares of common stock as a result of a 10% stock dividend declared on December 15, 2013.
2. Issued 60,000 shares of common stock for cash at $5 per share.
3. Corrected an error that had understated the net income for 2012 by $140,000.
4. Declared and paid a cash dividend of $300,000.
5. Earned net income of $600,000.
Instructions
Prepare the stockholders’ equity section of the balance sheet at December 31, 2014.
Total stockholders’ equity $5,340,000
PROBLEMS: SET C
Visit the book's companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.
CONTINUING COOKIE CHRONICLE
(Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 13.)
CCC14 After establishing their company's fiscal year-end to be October 31, Natalie and Curtis began operating Cookie & Coffee Creations Inc. on November 1, 2014. On that date, they issued both preferred and common stock. After the first year of operations, Natalie and Curtis want to prepare financial information for the year.
Go to the book's companion website, www.wiley.com/college/weygandt, to see the completion of this problem.
Broadening Your Perspective
Financial Reporting and Analysis
Financial Reporting Problem: Apple Inc.
BYP14-1 The financial statements of Apple Inc. are presented in Appendix A. Instructions for accessing and using the company's complete annual report, including the notes to the financial statements, are also provided in Appendix A.
Instructions
Refer to Apple's financial statements and answer the following question.
What amount, if any, did Apple declare in dividends on common stock in the year ended September 24, 2011?
Comparative Analysis Problem:
PepsiCo, Inc. vs. The Coca-Cola Company
BYP14-2 PepsiCo's financial statements are presented in Appendix B. Financial statements of The Coca-Cola Company are presented in Appendix C. Instructions for accessing and using the complete annual reports of PepsiCo and Coca-Cola, including the notes to the financial statements, are also provided in Appendices B and C, respectively.
Instructions
(a) Compute earnings per share and return on common stockholders’ equity for both companies for 2011. Assume PepsiCo's weighted-average shares were 1,580 million and Coca-Cola's weighted-average shares were 2,284 million. Can these measures be used to compare the profitability of the two companies? Why or why not?
(b) What was the total amount of dividends paid by each company in 2011?
Comparative Analysis Problem:
Amazon.com, Inc. vs. Wal-Mart Stores, Inc.
BYP14-3 Amazon.com, Inc.'s financial statements are presented in Appendix D. Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E. Instructions for accessing and using the complete annual reports of Amazon and Wal-Mart, including the notes to the financial statements, are also provided in Appendices D and E, respectively.
(a) What are the basic earnings per share for both Amazon and Wal-Mart as of December 31, 2011, and January 31, 2012, respectively?
(b) What was the total amount of dividends, if any, paid by Amazon for the year ending December 31, 2011? What was the total dividends paid by Wal-Mart for the year ending January 31, 2012?
Real-World Focus
BYP14-4 Use the stockholders’ equity section of an annual report and identify the major components.
Address: www.annualreports.com, or go to www.wiley.com/college/weygandt
Steps
1. From the Annual Reports Homepage, choose Search by Alphabet, and choose a letter.
2. Select a particular company.
3. Choose Annual Report.
4. Follow instructions below.
Instructions
Answer the following questions.
(a) What is the company's name?
(b) What classes of capital stock has the company issued?
(c) For each class of stock:
(1) How many shares are authorized, issued, and/or outstanding?
(2) What is the par value?
(d) What are the company's retained earnings?
(e) Has the company acquired treasury stock? How many shares?
Critical Thinking
Decision-Making Across the Organization 
BYP14-5 The stockholders’ equity accounts of Gonzalez, Inc., at January 1, 2014, are as follows.
| Preferred Stock, no par, 4,000 shares issued | $400,000 |
| Common Stock, no par, 140,000 shares issued | 700,000 |
| Retained Earnings | 550,000 |
During 2014, the company had the following transactions and events.
| July | 1 | Declared a $0.50 cash dividend per share on common stock. |
| Aug. | 1 | Discovered a $72,000 overstatement of 2013 depreciation expense. (Ignore income taxes.) |
| Sept. | 1 | Paid the cash dividend declared on July 1. |
| Dec. | 1 | Declared a 10% stock dividend on common stock when the market price of the stock was $12 per share. |
| 15 | Declared a $6 per share cash dividend on preferred stock, payable January 31, 2015. | |
| 31 | Determined that net income for the year was $320,000. |
Instructions
With the class divided into groups, answer the following questions.
(a) Prepare a retained earnings statement for the year. There are no preferred dividends in arrears.
(b) Discuss why the overstatement of 2013 depreciation expense is not treated as an adjustment of the current year's income.
(c) Discuss the reasons why a company might decide to issue a stock dividend rather than a cash dividend.
Communication Activity
BYP14-6 In the past year, Gosser Corporation declared a 10% stock dividend, and Jenks, Inc. announced a 2-for-1 stock split. Your parents own 100 shares of each company's $50 par value common stock. During a recent phone call, your parents ask you, as an accounting student, to explain the differences between the two events.
Write a letter to your parents that explains the effects of the two events on them as stockholders and the effects of each event on the financial statements of each corporation.
Ethics Case
BYP14-7 Molina Corporation has paid 60 consecutive quarterly cash dividends (15 years). The last 6 months, however, have been a cash drain on the company, as profit margins have been greatly narrowed by increasing competition. With a cash balance sufficient to meet only day-to-day operating needs, the president, Rob Lowery, has decided that a stock dividend instead of a cash dividend should be declared. He tells Molina's financial vice president, Debbie Oler, to issue a press release stating that the company is extending its consecutive dividend record with the issuance of a 5% stock dividend. “Write the press release convincing the stockholders that the stock dividend is just as good as a cash dividend,” he orders. “Just watch our stock rise when we announce the stock dividend. It must be a good thing if that happens.”
Instructions
(a) Who are the stakeholders in this situation?
(b) Is there anything unethical about Lowery's intentions or actions?
(c) What is the effect of a stock dividend on a corporation's stockholders’ equity accounts? Which would you rather receive as a stockholder—a cash dividend or a stock dividend? Why?
All About You
BYP14-8 In this textbook, you learned that in response to the Sarbanes-Oxley Act, many companies have implemented formal ethics codes. Many other organizations also have ethics codes.
Instructions
Obtain the ethics code from an organization that you belong to (e.g., student organization, business school, employer, or a volunteer organization). Evaluate the ethics code based on how clearly it identifies proper and improper behavior. Discuss its strengths, and how it might be improved.
FASB Codification Activity
BYP14-9 If your school has a subscription to the FASB Codification, go to http://aaahq.org/ ascLogin.cfm to log in and prepare responses to the following.
(a) What is the stock dividend?
(b) What is a stock split?
(c) At what percentage point does the issuance of additional shares qualify as a stock dividend, as opposed to a stock split?
Answers to Chapter Questions
Answers to Insight and Accounting Across the Organization Questions
p. 653 Up, Down, and ?? Q: What factors must management consider in deciding how large a dividend to pay? A: Management must consider the size of the company's retained earnings balance, the amount of available cash, the company's expected near-term cash needs, the company's growth opportunities, and what level of dividend the company will be able to sustain based upon its expected future earnings.
p. 657 A No-Split Philosophy Q: Why does Warren Buffett usually oppose stock splits? A: Buffett prefers to attract shareholders who will make a long-term commitment to his company, as opposed to traders who will only hold their investment for a short period of time. He believes that a high stock price discourages short-term investment.
Answers to Self-Test Questions
1. a 2. c 3. c 4. a $80,000 − [(3,000 × 7% × $100) × 2] 5. d (100,000 × 10% × $30) 6. d 7. c 8. b 9. d 10. b $186,000 − (6% × $100 × 10,000) 5 $126,000; ($1,200,000 + $1,600,000)÷− 5 $1,400,000; ($126,000÷$1,400,000) 11. c 12. d ($176,000 − $66,000 − $20,000) × 30% 13. b 14. d 15. b ($490,000÷ 100,000)
A Look at IFRS
The basic accounting for cash and stock dividends is essentially the same under both GAAP and IFRS although IFRS terminology may differ.
Compare the accounting for dividends, retained earnings, and income reporting under GAAP and IFRS.
Key Points
- The term reserves is used in IFRS to indicate all non–contributed (non–paid-in) capital. Reserves include retained earnings and other comprehensive income items, such as revaluation surplus and unrealized gains or losses on available-for sale securities.
- IFRS often uses terms such as retained profits or accumulated profit or loss to describe retained earnings. The term retained earnings is also often used.
- The accounting related to prior period adjustment is essentially the same under IFRS and GAAP. IFRS addresses the accounting for errors in IAS 8 (“Accounting Policies, Changes in Accounting Estimates, and Errors”). One area where IFRS and GAAP differ in reporting relates to error corrections in previously issued financial statements. While IFRS requires restatement with some exceptions, GAAP does not permit any exceptions.
- The stockholders’ equity section is essentially the same under IFRS and GAAP. However, terminology used to describe certain components is often different. These differences are discussed in Chapter 13.
- Equity is given various descriptions under IFRS, such as shareholders’ equity, owners’ equity, capital and reserves, and shareholders’ funds.
- The income statement using IFRS is called the statement of comprehensive income. A statement of comprehensive income is presented in a one- or two-statement format. The single-statement approach includes all items of income and expense, as well as each component of other comprehensive income or loss by its individual characteristic. In the two-statement approach, a traditional income statement is prepared. It is then followed by a statement of comprehensive income, which starts with net income or loss and then adds other comprehensive income or loss items. Regardless of which approach is reported, income tax expense is required to be reported.
- The computations related to earnings per share are essentially the same under IFRS and GAAP.
Looking to the Future
The IASB and the FASB are currently working on a project related to financial statement presentation. An important part of this study is to determine whether certain line items, subtotals, and totals should be clearly defined and required to be displayed in the financial statements. For example, it is likely that the statement of stockholders’ equity and its presentation will be examined closely.
Both the IASB and FASB are working toward convergence of any remaining differences related to earnings per share computations. This convergence will deal with highly technical changes beyond the scope of this textbook.
IFRS Practice
IFRS Self-Test Questions
1. The basic accounting for cash dividends and stock dividends:
(a) is different under IFRS versus GAAP.
(b) is the same under IFRS and GAAP.
(c) differs only for the accounting for cash dividends between GAAP and IFRS.
(d) differs only for the accounting for stock dividends between GAAP and IFRS.
2. Which item in not considered part of reserves?
(a) Unrealized loss on available-for-sale investments.
(b) Revaluation surplus.
(c) Retained earnings.
(d) Issued shares.
3. Under IFRS, a statement of comprehensive income must include:
(a) accounts payable.
(b) retained earnings.
(c) income tax expense.
(d) preference stock.
4. Which set of terms can be used to describe total stockholders’ equity under IFRS?
(a) Shareholders’ equity, capital and reserves, other comprehensive income.
(b) Capital and reserves, shareholders’ equity, shareholders’ funds.
(c) Capital and reserves, retained earnings, shareholders’ equity.
(d) All of the above.
5. Earnings per share computations related to IFRS and GAAP:
(a) are essentially similar.
(b) result in an amount referred to as earnings per share.
(c) must deduct preferred (preference) dividends when computing earnings per share.
(d) All of the above.
IFRS Exercise
International Financial Reporting Problem: Zetar plc
IFRS14-1 The financial statements of Zetar plc are presented in Appendix F. Instructions for accessing and using the company's complete annual report, including the notes to its financial statements, are also provided in Appendix F.
Instructions
Use the company's annual report to answer the following questions.
(a) Did the company declare and pay any dividends for the year ended April 30, 2011?
(b) Compute the company's return on ordinary shareholders’ equity for the year ended April 30, 2011.
(c) What was Zetar's earnings per share for the year ended April 30, 2011?
Answers to IFRS Self-Test Questions
Remember to go back to The Navigator box on the chapter opening page and check off your completed work.
__________
1A complete retained earnings statement is shown in Illustration 14-14 on the next page.
2The calculation of the weighted average of common shares outstanding is discussed in advanced accounting courses.
3The ratio of the market price per share to the earnings per share is called the price/earnings (P/E) ratio. The financial media report this ratio for common stocks listed on major stock exchanges.