14 Corporations: Dividends, Retained

Earnings, and Income Reporting

Learning Objectives
1 Explain how to account for cash dividends.

Explain how to account for stock dividends and

2 splits.

Prepare and analyze a comprehensive stockholders’

3
equity section.

Describe the form and content of corporation

4
income statements.

14-1
 Explain how to account for cash
LEARNING
1
OBJECTIVE dividends.

Dividends are distribution of cash or stock to

stockholders on a pro rata (proportional to ownership)
basis.

Types of Dividends:
1. Cash dividends. 3. Stock dividends.
2. Property dividends. 4. Scrip (promissory
note).
Cash dividends are generally reported quarterly as a
dollar amount per share.

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 Cash Dividends

For a corporation to pay a cash dividend, it must

have:
1. Retained earnings - Payment of cash dividends
from retained earnings is legal in all states.

2. Adequate cash.

3. A declaration of dividends by the Board of

Directors.

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 Cash Dividends

Three dates are important: Illustration 14-1

Key dividend
dates

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 Cash Dividends

Illustration: On Dec. 1, 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
payable on Jan. 20 to shareholders of record on Dec. 22.

Dec. 1 (Declaration Date)

Retained Earnings 50,000
Dividends Payable 50,000

Dec. 22 (Date of Record) No entry

Jan. 20 (Payment Date)

Dividends Payable 50,000
Cash 50,000
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 Dividend Preferences

u Right to receive dividends before common stockholders.

u Per share dividend amount is stated as a percentage of

the preferred stock’s par value or as a specified amount.

u Cumulative Dividend
Preferred stockholders
must be paid both
current-year dividends and
any unpaid prior-year
dividends before common
stockholders receive
dividends.
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 Dividend Preferences

CUMULATIVE DIVIDEND
Illustration: Scientific Leasing has 5,000 shares of 7%, $100
par value, cumulative preferred stock outstanding. Each $100
share pays a $7 dividend (.07 x $100). The annual dividend is
$35,000 (5,000 x $7 per share). If dividends are two years in
arrears, preferred stockholders are entitled to receive the
following dividends in the current year.
Illustration 14-2
Computation of total dividends to preferred stock

14-7 Advance slide in slide show to reveal dividend amounts. LO 1

 Dividend Preferences

ALLOCATING CASH DIVIDENDS BETWEEN

PREFERRED AND COMMON STOCK

Holders of cumulative preferred stock must be paid

any unpaid prior-year dividends and their current
year’s dividend before common stockholders receive
dividends.

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 ALLOCATING CASH DIVIDENDS

Illustration: On December 31, 2017, 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. At December 31, 2017, the directors declare
a $6,000 cash dividend. Prepare the entry to record the
declaration of the dividend.

Retained Earnings 6,000

Dividends Payable 6,000

Preferred Dividends: 1,000 shares x $100 par x 8% =

$8,000

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 ALLOCATING CASH DIVIDENDS

Illustration: At December 31, 2018, IBR declares a

$50,000 cash dividend. Show the allocation of
dividends to each class of stock.

$ 50,000
2,000 **
8,000 *
$ 40,000

* 1,000 shares x $100 par x 8% = $8,000

** 2017 Pfd. dividends $8,000 – declared $6,000 = $2,000

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 ALLOCATING CASH DIVIDENDS

Illustration: At December 31, 2018, IBR declares a

$50,000 cash dividend. Prepare the entry to record the
declaration of the dividend.

Retained Earnings 50,000

Dividends Payable 50,000

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 DO IT! 1 Dividends on Preferred and
Common Stock

MasterMind Corporation has 2,000 shares of 6%, $100 par

value preferred stock outstanding at December 31, 2017. At
December 31, 2017, 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.
Solution

Preferred stockholders are paid only this year’s dividend.

Preferred stockholders = $12,000 (2,000 x .06 x $100).
Common stockholders = $48,000 ($60,000 - $12,000).

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 DO IT! 1 Dividends on Preferred and
Common Stock

MasterMind Corporation has 2,000 shares of 6%, $100 par

value preferred stock outstanding at December 31, 2017. At
December 31, 2017, the company declared a $60,000 cash
dividend. Determine the dividend paid to preferred stockholders
and common stockholders under each of the following scenarios.
2. The preferred stock is noncumulative, and the company did
not pay a dividend in each of the two previous years.
Solution

Past unpaid dividends do not have to be paid.

Preferred stockholders = $12,000 (2,000 x .06 x $100).
Common stockholders = $48,000 ($60,000 - $12,000).

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 DO IT! 1 Dividends on Preferred and
Common Stock

MasterMind Corporation has 2,000 shares of 6%, $100 par

value preferred stock outstanding at December 31, 2017. At
December 31, 2017, the company declared a $60,000 cash
dividend. Determine the dividend paid to preferred stockholders
and common stockholders under each of the following scenarios.
3. The preferred stock is cumulative, and the company did not
pay a dividend in each of the two previous years.
Solution

Dividends that have been missed (dividends in arrears) must

be paid.
Preferred stockholders = $36,000 (3 x 2,000 x .06 x $100).
Common stockholders = $24,000 ($60,000 - $36,000).
14-14 LO 1
 Explain how to account for stock
LEARNING
2
OBJECTIVE dividends and splits.

Stock Dividends
A pro rata (proportional to ownership) distribution
of the corporation’s own stock to stockholders.

Reasons why corporations issue stock dividends:

1. Satisfy stockholders’ dividend expectations
without spending cash.

2. Increase marketability of the corporation’s stock.

3. Emphasize that a portion of stockholders’ equity

has been permanently reinvested in the business.
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 Stock Dividends

u Small stock dividend (less than 20% of the

corporation’s issued stock, recorded at fair market
value of the shares to be issued) *

u Large stock dividend (equal to or greater than

20% of issued stock, recorded at par value)

* Accounting based on the assumption that a small

stock dividend will have little effect on the market price of
the outstanding shares.

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 ENTRIES FOR STOCK DIVIDENDS

Illustration: Medland Corporation declares a 10% stock

dividend on its 50,000 shares of $10 par value common
stock. The current fair market value of its stock is $15 per
share. Record the entry on the declaration date:

Retained Earnings (50,000 x 10% x $15) 75,000

Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par— 25,000
Common
Statement Presentation Illustration 14-4

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 ENTRIES FOR STOCK DIVIDENDS

Illustration: Medland Corporation declares a 10% stock

dividend on its 50,000 shares of $10 par value common
stock. The current fair market value of its stock is $15 per
share. Record the entry on the declaration date:

Stock Dividends (50,000 x 10% x $15) 75,000

Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par— 25,000
Common
Record the journal entry when Medland issues the dividend shares.

Common Stock Dividends 50,000

Distributable
Common Stock 50,000

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 Stock Dividends

EFFECTS OF STOCK DIVIDENDS

Illustration 14-5

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 Stock Dividends

Question
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 value 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.
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 Stock Dividends

Question
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. current liability.

c. deduction from retained earnings.

d. addition to capital stock.

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 Stock Splits

u Issuance of additional shares to stockholders

according to their percentage ownership.

u Reduction in the par or stated value per share.

u Increase in number of shares outstanding.

u Reduces the market value of shares.

u No journal entry recorded.

Helpful Hint
A stock split changes
the par value per
share but does not
affect any balances in
stockholders’ equity.

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 Stock Splits

Effect of 4-for-1 stock split for stockholders

Illustration 14-6

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 Stock Splits

Effects for Medland Corporation, assuming that it splits its

50,000 shares of common stock on a 2-for-1 basis.
Illustration 14-7

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14-25
14-26
 Berkshire Hathaway

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).
14-27 LO 2
 DO IT! 2 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, total
stockholders’ equity, and par value per share.

14-28 LO 2
 DO IT! 2 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. President Joan Elbert is considering
either a 10% stock dividend or a 2-for-1 stock split.

14-29 LO 2
 Prepare and analyze a comprehensive
LEARNING
3
OBJECTIVE stockholders’ equity section.

Retained earnings is net income that a company

retains in the business.
u Part of the stockholders’ claim on the total assets
of the corporation.

u Debit balance in Retained Earnings is identified as

a deficit.

Illustration 14-10
Stockholders’
equity with deficit

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 Retained Earnings

RETAINED EARNINGS RESTRICTIONS

Restrictions can result from:
1. Legal restrictions.
2. Contractual restrictions.
3. Voluntary restrictions.
Illustration 14-11
Disclosure of restriction

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 Retained Earnings

PRIOR PERIOD ADJUSTMENTS

u Correction of an error in previously issued financial
statements.

u Result from:
► mathematical mistakes.
► mistakes in application of accounting principles.
► oversight or misuse of facts.

u Adjustment made to the beginning balance of

retained earnings.

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 RETAINED EARNINGS STATEMENT

Before issuing the report for the year ended December 31, 2017, you
discover a $50,000 error (net of tax) that caused the 2016 inventory to
be overstated (overstated inventory caused COGS to be lower and thus
net income to be higher in 2016. Would this discovery have any impact
on the reporting of the Statement of Retained Earnings for 2017?

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 RETAINED EARNINGS STATEMENT

14-34 Advance slide in slide show to reveal answer. LO 3

 RETAINED EARNINGS STATEMENT

Debits and Credits to Retained

Earnings Illustration 14-13

14-35 LO 3
 RETAINED EARNINGS STATEMENT

Illustration 14-14
Retained earnings
statement

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 RETAINED EARNINGS STATEMENT

Question
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. some disposals of treasury stock below cost.

d. sales of treasury stock above cost.

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 Statement Presentation and Analysis
Illustration 14-15
Comprehensive stockholders’
equity section

14-38 LO 3
 Statement Presentation and Analysis

ANALYSIS
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.
Illustration 14-16

Ratio shows how many dollars of net income the company earned
for each dollar invested by the common stockholders.

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 Retained Earnings
DO IT! 3 Statement

Vega Corporation has retained earnings of

$5,130,000 on January 1, 2017. During the year,
Vega earned $2,000,000 of net income. It declared
and paid a $250,000 cash dividend. In 2017, Vega
recorded an adjustment of $180,000 due to the
understatement (from a mathematical error) of
2016 depreciation expense. Prepare a retained
earnings statement for 2017.

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 Retained Earnings
DO IT! 3 Statement

Prepare a retained earnings statement for 2017.

14-41 Advance slide in slide show to reveal the missing amounts. LO 3

 Describe the form and content of
LEARNING
4
OBJECTIVE corporation income statements.

Income
Statement
Presentation

Illustration 14-
17
Income
statement with
14-42 income taxes LO 4
 Income Statement Analysis

EPS AND PREFERRED DIVIDENDS

Net Income minus
Earnings Preferred Dividends
=
Per Share
Weighted-Average Common
Shares Outstanding

Ratio indicates the net

income earned by each
share of outstanding
common stock.

14-43 LO 4
 Income Statement Analysis

Question
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. ($490,000 / 100,000 = $4.90)

c. $2.10.
d. No correct answer is given.

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14-45 LO 4
 Stockholders’ Equity and
DO IT! 4 EPS

(a) Compute return on common stockholders’ equity for each year.

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 Stockholders’ Equity and
DO IT! 4 EPS

(b) Compute earnings per share for each year.

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14-48