Corporate Reporting: Income, Earnings per Share, Retained Earnings

To pay dividends, a corporation must: Have enough retained earnings and cash

Declare a dividend payable

Declaration date: Board of directors formally declares dividend

Commits company to a legal obligation

Declaration is recorded:

Cash Dividends

Dec. 1 Cash Dividends - Preferred 50,000

Dividends Payable 50,000

To record declaration of cash dividend

Record date: Ownership of shares is determined

Shareholders of record on this date will receive dividend

No journal entry required

Payment date: Dividend is paid to shareholders and recorded:

Cash Dividends

Jan. 23 Dividends Payable 50,000

Cash 50,000

To record payment of cash dividend

Also called stock dividends Distribution of corporation’s own shares to its

shareholders Does not change assets or shareholders’ equity Satisfies shareholders' dividend expectations

without spending cash Increasing number of shares will cause market

price to decrease and make shares more affordable

Emphasizes that a portion of shareholders’ equity has been permanently retained in the business Therefore unavailable for cash dividends

Share Dividends

Declaration date:

Issue (payment) date:

Entries for Share Dividends

June 30 Share Dividends - Common 75,000

Common Share Dividends Distributable 75,000

To record declaration of 10% stock dividend

Aug. 5 Common Share Dividends Distributable 75,000

Common Shares 75,000

To record issue of 5,000 common shares in a

stock dividend

Involves the issue of additional shares to

shareholders Similar to a stock dividend

Increases the marketability of shares by lowering market value per share Effect on share price is generally inversely

proportional to size of split

Does not affect shareholders’ equity Therefore no entries are required

Stock Splits

Stock Splits

Assets Liabilities Share Capital Retained Earnings

Cash dividend - NE NE -

Stock dividend NE NE + -

Stock split NE NE NE NE

Shareholders' Equity

"-" Decrease "+" Increase "NE" No effect

Cash dividends reduce assets and shareholders’ equity (retained earnings) Stock dividends increase share capital and decrease retained earnings Stock splits have no effect (but do increase number of shares issued)

Income statement for corporations are the same as

proprietorship or a partnership

Major difference is income taxes

Since corporation is a separate legal entity

Affects income statement (income tax expense) and balance sheet (income tax payable)

Corporate Income Taxes

Sales 800,000$

Cost of goods sold 600,000

Gross profit 200,000

Operating expenses 50,000

Income from operations 150,000

Other revenues 10,000

Other expenses 4,000

Income before income tax 156,000

Income tax expense 46,800

Net income 109,200$

LEADS INC.

Income Sta tement

Year Ended December 31, 2008

Corporate Income Taxes

Interperiod tax allocation: Dividing income tax between amounts payable now and payable later Intraperiod tax allocation: Associating income taxes in a period with their related items of income

The cumulative total of income less losses and

less declared dividends since incorporation

Represents part of shareholder’s claim on total assets of a corporation Not a claim on any specific asset (including cash)

May be subject to restrictions that limit the amount that can be paid out as dividends: Contractual restrictions such as debt covenants

Voluntary restrictions imposed by the Board of Directors

Retained Earnings

A prior period adjustment results from: the correction of a material error in reporting net

income in a prior year, or the changing of an accounting principle

Accounting treatment: Use corrected amount or new principle in reporting

results for the current year Disclose cumulative effect of correction/change as an

adjustment to retained earnings, net of tax Correct/restate financial statements for prior periods Disclose effect of change in financial statements

Prior Period Adjustments

Correction is made directly to retained earnings

Since effect of error is now located there (all revenues and expenses have been closed to retained earnings)

Any corrections are net of any income tax effect

Example: overstatement of cost of goods sold

Understatement of inventory, net income (now retained earnings), and income tax payable

Correction of Prior Period Errors

Feb. 12 Merchandise Inventory 10,000

Income Tax Payable (at 30%) 3,000

Retained Earnings 7,000

To adjust foroverstatement of cost of goods sold in a prior period

Occurs when the principle used in current year is

different that that used in prior year

May be voluntary or prescribed (by the CICA)

Usually applied retroactively (prior years restated) unless not practical to do so

Comparative amounts are restated

Retained earnings is adjusted, net of tax

Similar to adjustment for correction of errors

Change in Accounting Principle

Reported in the statement of retained earnings

Adjustment is added to (subtracted from) opening balance of retained earnings, net of income tax effect

Financial statements of prior years are restated to reflect the change

Entries for Accounting Changes

Shows the changes in retained earnings during the

year

Transactions that affect retained earnings:

Statement of Retained Earnings

Debits (Decreases) Credits (Increases)

1. Correction of a prior period error that 1. Correction of a prior period error that

overstated income understated income

2. Cumulative effect of a change in accounting 2. Cumulative effect of a change in accounting

principle that decreased income principle that increased income

3. Net loss 3. Net income

4. Cash dividends

5. Stock dividends

6. Reacquisition of shares

Retained Earnings

Sample Statement of Retained Earnings

Balance, January 1, as previously reported $800,000

Add: Correction for overstatement of cost of goods sold in 2007,

net of $3,000 income tax expense 7,000

Less: Cumulative effect of change in amortizartion method, net of

$7,200 income tax savings (16,800)

Balance, January 1, as adjusted 790,200

Add: Net income 549,800

1,340,000

Less: Cash dividends $100,000

Stock dividends 200,000

Reacquisition of common shares 15,000 315,000

Balance, December 31 $1,025,000

GRABER INC.

Sta te me nt o f Re ta ine d Ea rning s (p a rtia l)

Ye a r End e d De ce mb e r 31, 2008

Also called net income per share

Indicates net income earned by each outstanding common share

Reported on the income statement Formula to calculate:

Weighted average number of common shares = shares issued during the year x the fraction of the year they are outstanding Example: April 1 = 3/12 months if calendar year used

Earnings per Share

Net income less Preferred Dividends

Weighted Average Number of Common Shares

Earnings per Share

Helps investors compare earnings of different

companies

Formula to calculate:

A high PE ratio is an indicator that investors believe the company has good earnings potential

Earnings Performance: Price-Earnings Ratio

Market Price per Share

Earnings per Share

Price-Earnings Ratio ÷ =

Indicates what percentage of earnings a

company is distributing to its shareholders Can be calculated for both common and

preferred shares:

Payout ratios vary with the industry Income trusts: very high ratios

High payout ratios can indicate that a company is not reinvesting enough in its operations

Payout Ratio

Cash Dividends Payout Ratio ÷ = Net income