Accounting for Corporations

Overview
Retained earnings represent the component of the shareholders’ equity arising form the
retention of assets generated from the profit-directed activities of the corporation.

At the end of an accounting period, the Income Summary account of a corporation is

closed to the Retained Earnings account.

The retained earnings account is credited with the corporation’s profit or debited with the
loss.

Distributions to shareholders of cash, property or stocks from unrestricted retained

earnings on the basis of all issued and fully paid shares, and all subscribed par value
shares except treasury shares are called dividends. Dividend declarations reduce
retained earnings.
Overview
Other less common situation that cause increases or decreases in retained earnings are as
follows:

 debits resulting from reissuance of treasury stocks below cost

 loss on retirement of treasury stocks

 debits or credits for prior period errors

Prior period errors are errors discovered in the current period

that are such significance that the financial statements of one or
more prior periods can no longer be considered to have been
reliable at the date of their issue. Note that credit entries increase
the retained earnings balance and debits decrease it.
Overview

A debit balance in the Retained Earnings account resulting from accumulated

losses is called a deficit.

Retained earnings may be restricted or appropriated, and unrestricted or

unappropriated.

 Unrestricted retained earnings are free and can be declared

as dividends.

 Retained earnings restrictions may be legal, contractual or

voluntary.
Dividends in General

Shareholders are not guaranteed dividends and dividends

do not
become a liability of the company until the board
of directors has formally declared a dividend
distribution.

Section 43 of the Corporation Code States that dividends should only be

declared out of the unrestricted retained earnings.
Thus, dividends cannot be declared out of the legal capital of the
corporation for the security of its creditors.
Date of Declaration
 On the date of declaration, the board of directors will adopt a
resolution declaring that a dividend is to be paid.

 The resolution will specify the amount, type and date of

payment of this dividend.

 It will also set a date of record.

 Cash dividends are declared solely by the board of directors

while share dividends will necessitate the concurrence of at
least two-thirds of the outstanding shareholders.
Date of Declaration

Legally, declared dividends are obligations of the firm. Dividends to be

paid in cash or property become a liability on this date. Shares distributable
is also recognized.

An entry is made debiting Retained Earnings and crediting a

dividend liability or Shares Distribute account.

Some companies debit a Dividends Declared account instead of the Retained

Earning account. This account is nevertheless closed to the Retained Earnings
account at the end of the year.
Date of Record

A list of shareholder entitled to the declared dividends is prepared at

the date of record.

Note: If an investor buys a share of stock after this date, he will not
receive the dividend . The share is said to be traded ex-dividend.
No entry is required on this date.
Date of Payment

The corporation settles its liability on this date.

An entry is made debiting the dividend liability or shares

distributable account and crediting cash, property
distributed or share capital.
Cash Dividends

In declaring cash dividends, a company must have both an appropriate

amount of retained earnings and the necessary amount of cash

Dividends on par value shares are stated as a certain percentages of the

par value

As to no-par value shares, the dividends are stated at a certain amount per
share

When the board of directors declares a cash dividend, an entry is made

debiting Retained Earnings and crediting Cash Dividends Payable.
 Illustration

The Corporation declared a cash dividend of P12 per share of ordinary shares on July 1.
The dividends are payable on August 1 to shareholders of record on July 21. The
Corporation has 100,000 ordinary shares issued of which 7,000 shares are held in
treasury.
Note

With the exception of treasury shares, all issued and

fully paid shares, and all subscribed par value shares
are entitled to dividends when declared. The
subscribed shares must be a par value shares. No par
value shares are legally issued only when fully paid.
Unissued shares, subscribed no par shares and
treasury shares are not entitled to dividends.
Property Dividends

A distribution to shareholders that is payable in non-cash assets

is generally referred to as property dividends or dividends in
kind.

Per IFRIC 17, paragraph 11, an entity shall measure a liability to

distribute non-cash assets as a dividend to its owners at the fair value
of the assets to be distributed.
 Illustration

A company has 5,000 shares investment in another entity

accounted for as nonmarketable equity instruments. The
carrying amount of this investment is P500,000. On December
1, 2014, the Company declared as property dividends this
investment to all its outstanding par value shares to be
distributed n December 15, 2014. the FMV of the investment at
the declaration date was P950,000. There was no change to fair
value on settlement date.
Share Dividends

A corporation may distribute to shareholders additional shares of the

company’s own share as share dividends.

This type of dividend affects only the accounts within the shareholders’
equity.
 Share dividends increase the total share capital and decrease the
retained earnings account.
 Because both of these are components of shareholders’ equity, total
shareholders’ equity is uncharged
Small Share Dividends
Small share dividends are dividends in which the additional shares
issued are less than 20% of the previously outstanding shares.

These share dividends are recorded by transferring from retained

earnings to share capital (ordinary shares and share premium
accounts ) the fair market value of the additional shares to be
issued.

In case when the fair market value is lower than the par or stated
value, the par or stated value will be the basis for recording.
The shareholders’ equity of the company before declaration of a 10% share
dividend is as follows:

Ordinary shares, P50 par, 20,000 shares

issued and outstanding 1,000,000
Share Premium 200,000
Total Share Capital 1,200,000
Retained Earnings 650,000
Total SHE 1,850,000

Assume that market price per share is P110.

Large Share Dividend

If the share dividend is 20% or more of the previously

outstanding shares such that the effect is to reduce materially the
market value per share, then only the par or stated value is
credited to ordinary shares with a corresponding debit to
retained earnings.

Large dividends are recorded at par value.

Use the same data and the Corporation declared a 20% share dividend on its
20,000 issued and outstanding P50 par value shares. The company will issue
additional 4,000 shares due to the share dividend.
Liquidating Dividends

Liquidating dividends are not distributions of earnings but

rather returns of capital to the investing shareholders. This type
of dividend can be legally paid only under either of the following
circumstances:
(1) when the corporation is under dissolution and liquidation o
(2) when the corporation is engaged in the exploration of
natural resources.
Share Splits
Corporations reduce the par or stated value of its share capital and issues
additional shares to its shareholders through the practice referred to as share
splits.
The par or stated value per share will decrease with a corresponding increase
in the number of authorized, issued and outstanding shares. In effect, there is
no change in the balances of the shareholders’ equity accounts.
The following are some reasons behind a share split:
To adjust the market price of the company’s shares to a level where more
individuals can afford to invest in the stock.
To spread the shareholder base by increasing the number of outstanding
shares.
To benefit existing shareholders by allowing them to take advantage of an
imperfect adjustment following the split.
Share Splits
When shares are selling below a desired price or when management wishes to
take control of the company, the corporation may consider a reverse split
that can be accomplished by increasing the par or stated value of its share and
reducing the share outstanding.

There will be no journal entry required; a memo entry is sufficient.

The Company has 10,000 P100 par value ordinary shares issued and
outstanding when the board of directors decided to split the share 5-for-1.

This means that a shareholder would receive five shares with a new par value
of P20 for each share held. Ordinary shares will remain unchanged at
P1,000,000. The issued and outstanding shares will now be 50,000 and the par
value reduce to P20 per share.
Dividends on Preference and Ordinary Shares
A corporation may issue both preference and ordinary shares. Preference
shares enjoy preference as to dividends. When the board of directors declares
cash dividends, preference shareholders are entitled to dividend before
ordinary shareholders receive any distribution.

The dividend is stated as a percentage of the par value preference shares.

Thus, holders of 7% of preference shares with a par value of P100 are entitled
to an annual dividend of P7 per share before any distribution is made to the
ordinary shareholders.
Dividends on Preference and Ordinary Shares

The corporation is not obliged to declare dividends annually. When the board
does not declare dividends, the dividends for cumulative preference shares
accumulate; these are called dividends in arrears. Preference shares may
contain one of the following combinations of features:

Non-cumulative and non-participating

Cumulative and participating

Non-cumulative and participating

Cumulative and non-participating

Dividends on Preference and Ordinary Shares
Non-Cumulative Preference Shares

These shares entitle the holders only to the

payment of current dividends, if and when
dividends are declared, to the extent of the
preference rate, before the ordinary shareholders are
paid.

If there is no dividend declaration for a certain year,

then dividend for that year is forfeited
Dividends on Preference and Ordinary Shares
Cumulative Preference Shares

These shares entitle the holder to payment not only of current

dividends but also of back dividends or dividends in
arrears, if and when dividends are declared, before the ordinary
shareholders are paid.
Dividends on Preference and Ordinary Shares
Non-Participating Preference Shares

These shares entitle the holders only to the

extent of the stipulated preference
dividend
Dividends on Preference and Ordinary Shares
Participating Preference Shares

These shares entitle the holders to participate with the

holders of ordinary shares pro-rata in the remainder after
the ordinary shareholders have received their initial share based
on the preference rate.
Illustration
The Corporation has the following selected accounts in its SHE.
12% Preference Shares, P100 par, authorized
4,00 shares, 2,000 shares issued and
outstanding 200,000
Ordinary Shares, P100 par, authorized 6,000
shares, 3,000 shares issued and outstanding 300,000
Retained Earnings 260,000

The Board failed to declare dividends for the past two years. The current year’s
results of operations gave the board to declare cash dividends of P200,000.
1. Non-cumulative and Non-participating Preference Shares
2. Non-cumulative and Participating Preference Shares
3. Cumulative and Non-participating Preference Shares
4. Cumulative and Participating Preference Shares
Prior Period Errors
Per International Accounting Standards (IAS) No.8, Accounting Policies,
Changes in Accounting Estimate and Errors, prior period errors are omissions
from and other misstatements of the entity’s financial statements for one or
more prior periods that are discovered in the current period.

Errors may occur as a result of mathematical mistakes, mistakes in applying

accounting policies, misinterpretation of facts, fraud or oversights.

Examples include errors in the estimation of depreciation, errors in inventory

valuation, and omission of accruals revenue and expenses.
Prior Period Errors
The amount of the correction of a prior period error that relates to prior periods
should be reported by adjusting the opening balances of retained earnings and
affected assets and liabilities.

If an error resulted in an understatement of profit in previous

periods, a correcting entry would be needed to increase
retained earnings. If an error overstated profit in prior
periods, then retained earnings would have to be
decreased.
Restrictions on Retained Earnings
A corporation may be required by law or contractual arrangements to set aside
a portion of the retained earnings for specified purposes. In addition, the board
of directors may voluntarily designate a portion of retained earnings for future
expenses, contingencies or other purposes (SFAS No. 18, par. 31).

This portion of the retained earnings is referred to as restricted or

appropriated retained earnings.
A Company bought 1,000 of its shares at P150,000. a portion of the retained
earnings is restricted for the cost of the treasury purchased.

Retained Earnings 150,000

Appropriated Retained Earnings 150,000

Reverse once the purpose of the restriction has been served.

Statement of Retained Earnings
This statement is not required per revised International Accounting Standards
(IAS) No. 1. A retained earnings statement is normally divided into two major
sections:
• Appropriated. This section presents the beginning balance of the retained
earnings appropriated account, any additions or deductions during the
period, and ending balance.
• Unappropriated. This section shows the beginning balance of the retained
earnings unappropriated account, correction of prior period error, profit or
loss for the period, dividends, transfers to and from the appropriated and
unappropriated accounts, and the ending balance.
Statement of Changes in Shareholders’ Equity
Significant changes in shareholders’ equity should be reported in the period in
which they occur. The statement of changes in shareholders’ equity may be
prepared in columnar format, where each column represents a major
shareholders’ equity classification.
Book Value Per Share
 is the amount that would be paid on each share if the corporation is
liquidated.

 When only a single class of share is outstanding, the book value per share
is computed by dividing the total shareholders’ equity by the number of
shares outstanding.

Assume that a Corporation has a total shareholders’ equity of P180,000

and 5,000 shares of ordinary shares outstanding. BV per SHARE?
Book Value Per Share
When both preference and ordinary shares are outstanding, the
preference shareholders have preference over ordinary shareholders
as to the distribution of assets upon corporate liquidation.

The preference shareholders have the right to receive assets equal

to the par value or a larger stated liquidation value per share.
Liquidation value is the cash price or other consideration
that can be received in a forced sale of assets such as that occurring
when a firm is in the process of going out of business. Typically, the
liquidation value is less than what could be received from selling
assets in the ordinary course of business,
Book Value Per Share

The book value per share of the preference shares is the sum of its
liquidation value, if applicable, plus any current and dividends in arrears
divided by the number of preference shares outstanding.

Ordinary shareholders’ equity is obtained by deducting from total SHE the

preference SHE. The book value per share is computed by dividing
ordinary shareholders’ equity by the number of ordinary shares
outstanding.
The SHE section of the company’s statement of financial position is as follows:
6% Cumulative Non-Participating PS
1,000 par, 5,000 shares authorized,
400 shares issued and outstanding 400,000
Ordinary Shares, P100 par, 20,000 shares
authorized, 5,500 shares issued and
outstanding 550,000
Share Premium – PS 40,000
Share Premium – OS 720,000
Retained Earnings 850,000
TOTAL SHE 2,560,000

Suppose that PS has a liquidation value of P1,300 and dividends are in

arrears for three years. Compute for BV per shares PS and OS.
END