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To discuss the content of retained earnings. To study the accounting treatments for dividends (including cash dividend, property dividend, scrip dividend, and stock dividend). To learn the procedures for quasireorganization.
Stockholders' Equity (2)- Retained Earnings 2
Stockholders equity consists of primarily stockholders investments (i.e., contributed capital) and retained earnings. The primary factors that affect retained earnings besides net income (or net loss) include (1) dividends, (2) prior period adjustments, (3) appropriations, and (4) quasi-reorganizations.
Stockholders' Equity (2)- Retained Earnings 3
Dividends
While the net income increases the retained earnings, the distribution of dividends reduces the retained earnings. In order to declare dividends, a company must meet legal requirements and have assets available for distribution.
Stockholders' Equity (2)- Retained Earnings 4
Dividends (contd.)
Most companies regard the unrestricted retained earnings as the limit for dividends distribution. However, most states allow liquidating dividends (i.e., dividends pay out of contributed capital).*
*Note: as long as the total assets after dividends equal or exceed the sum of total liabilities and the amount needed to satisfy the rights of other classes of shareholders with higher priority in receiving assts at liquidation (Revised Model Business Corporation Act, 1994).
Stockholders' Equity (2)- Retained Earnings 5
Dividends (contd.)
Restrictions of retained earnings include: 1) Legal restrictions: Many states require a corporation to restrict the cost of treasury stock from dividends distribution. 2)Contractual restrictions: A long-term bond contract may limit the use of assets for payment of dividends as a loan condition, and therefore, restrict the use of retained earnings for dividends.
Stockholders' Equity (2)- Retained Earnings 6
Dividends:(contd.)
Restrictions (contd.) 3)Voluntary restrictions: Appropriation of retained earnings for specific purposes. The board of directors is responsible for the establishment of dividend policy and the determination of the amount, timing and types of dividends to be declared.
Dividends:(contd.)
A few types of dividends may be considered: (1) cash, (2) property, (3) scrip, (4) stock, and (5) liquidating dividends. Cash, property and scrip dividends decrease retained earnings (R/E) and the stockholders equity.
Dividends:(contd.)
Stock dividend decreases R/E but increases contributed capital in the same amount. So, there is no change in the total stockholders equity. Liquidating dividend decreases both contributed capital and the stockholders' equity.
Stockholders' Equity (2)- Retained Earnings 9
Cash Dividends
Four days are relevant to the cash dividend: 1) the date of declaration, 2) the ex-dividend date, 3) the date of record, and 4) the date of payment.
Stockholders' Equity (2)- Retained Earnings 10
Cash Dividends:(contd.)
Example: on Nov. 3, 20x5, the board of directors declares preferred dividends totaled $10,000 and common dividends totaled $20,000. These dividends are payable on 12/15/x5 to stockholders of record on 11/24/x5. In addition, the ex-dividend date is 11/20/x5. The journal entries for the declaration and other related events are:
Stockholders' Equity (2)- Retained Earnings 11
Cash Dividends:(contd.)
11/3/x5 the date of declaration Retained Earnings 30,000 Dividends Payable: CS 20,000 Dividends Payable: PS 10,000 Shares are traded with dividends attached after this date. Companies are legally liable for declared dividends on this date.
Cash Dividends:(contd.)
11/20/x5 Ex-dividend date. No entry or memo. It is usually 4 business dates prior to the date of record. Shares purchased on or after this date are purchased ex dividend-without the right to receive the declared dividend. Therefore, a decline in price equals the dividend declared in general occurs on this date.
Stockholders' Equity (2)- Retained Earnings 13
Cash Dividends:(contd.)
11/24/x5 The date of record Memo: the company will pay dividends on 12/15/x5 to preferred and common stockholders of record as of today, the date of record. Stockholders on the record will be paid of dividend even if they sell those shares prior to 12/15/x5, the payment date.
Cash Dividends:(contd.)
12/15/x5 Dividend payment date Div. Payable: Com. stk 20,000 Div. Payable: Prefer.stk 10,000 Cash 30,000
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A preference to dividends does not guarantee a dividend distribution. Because a dividend declaration is at the discretion of the board of directors.
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If a corporation fails to declare a dividend, or declares a dividend which is less than the stated rate of the preferred stock, the "passed" dividend of non-cumulative preferred stock will never be paid.
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For cumulative preferred stock, the amount of passed dividend becomes "dividend in arrears. The dividend in arrears has the highest priority to be paid in the following periods. Common stockholders cannot be paid any dividend until the preferred dividend in arrears has been paid.
Stockholders' Equity (2)- Retained Earnings 18
Dividend in arrears accumulate from period to period. The dividend in arrears is not a liability because no liability exists until the dividend declaration.
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Examples
Year 1: Case I: Dividends declared = $10,000 Com. STK shares outstanding: 10,000, @$5 Preferred STK outstanding : 5,000, @$10, dividend is 6% of the par value Dividends for P.S. = 6% *10*5,000= $3,000. Dividends for C.S. = ($10,000-3,000)=$7,000. Or $0.7 per share ($7,000/10,000 shares)
Stockholders' Equity (2)- Retained Earnings 20
Examples (contd.)
Case II: Same information as in Case I except that dividends declared = $1,000. Dividends for P.S. = $1,000. Div. Passed=$2,000 Dividends for C.S. = $0 If this is a cumulative P.S. the dividends in arrears equal $2,000 ($3,000-1,000). If this is a non-cumulative P.S., the $2,000 will never been paid.
Stockholders' Equity (2)- Retained Earnings 21
Examples (contd.)
Year 2: Continued from Case II of year 1, assuming a cumulative preferred stock and the dividends declared = $8,000. Dividends for P.S. => $2,000 (div. In arrears) $3,000 (div. Of year 2) $ 5,000 Dividends for C.S. => $8,000- $2,000-3,000 = $3,000
Stockholders' Equity (2)- Retained Earnings 22
When preferred stock is participating, preferred stockholders share with the common stockholders in any "extra" dividends. "Extra" dividends = the declared dividends - the stated dividends of preferred stock - Equal % of dividends as the preferred stock's stated dividends for common stock.
Stockholders' Equity (2)- Retained Earnings 23
Fully participating preferred stock: preferred stockholders share equally with the common stockholders in any "extra" dividends. These extra dividends are distributed proportionally, based on the respective par value of each class of stock.
Stockholders' Equity (2)- Retained Earnings 24
Partially participating preferred stock: preferred stockholders share in "extra" dividends with common stockholders, but its participation is limited to a fixed rate or amount per share.
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If the preferred stock is Not participating, the amount of dividends received by the common stockholders equals: the declared dividends - any "dividend in arrears" - the stated dividend of the preferred stock If the preferred stock is participating in extra dividends, calculation needs to be made for the allocation of dividends.
Stockholders' Equity (2)- Retained Earnings 26
Example: Assume a company issued 10% participating cumulative preferred stock with a total par value of $20,000 and common stock with a total par value of $30,000. Thus, preferred stock constitutes 40% and common stock 60% of the total par value. The company intends to distribute cash dividends of $9,000, and there are no dividends in arrears. The dividend distribution is as follows:
Stockholders' Equity (2)- Retained Earnings 27
$1,600 $3,600
2,400 $5,400
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Property Dividends
A property dividend is that dividend is payable in assets other than cash. Marketable securities are typically used for a property dividend. Because they are more easily distributable to the stockholders.
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Property Dividends
A property dividend is recorded at the fair market value of the asset transferred on the date of declaration. A gain or a loss is recognized (APB opinion no. 29, par. 18).
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Corp. Aron declares a property dividend, payable in bonds of Rock company being held to maturity. The bonds are carried on Arons book at a book value of $40,000 but the current market value on the declaration date is $48,000. The journal entries to record the property dividend are as follows:
Stockholders' Equity (2)- Retained Earnings 32
Gain on Disposal of Investment 2. Retained Earnings 48,000 Property Dividends Payable 48,000 Date of Payment Property Dividends Payable 48,000 Investment in Rock Company Bonds 48,000
Stockholders' Equity (2)- Retained Earnings 33
8,000 8,000
The Remley company declares a property dividend on 3/15/x5, Payable in Welch company stock. The Welch stock had been purchased early in 20x4 for $24,000 and was reported as an asset at a fair value of $29,000 on 12/31/x4 balance sheet.
Stockholders' Equity (2)- Retained Earnings 34
The market value of Welch stock is $31,000 on 3/15/x5. The following entries are made on 3/15/x5 (the declaration date): Adj. prior to the recog. Of dividends payable:
Fair Value Adjustment 2,000 Unrealized holding gain 2,000 Unrealized holding gain 7,000 Gain on Disposal of Investment 7,000
Stockholders' Equity (2)- Retained Earnings 35
31,000 31,000
31,000 24,000 7,000
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Scrip Dividends
A corporation with adequate retained earnings to meet legal dividend requirements but with insufficient funds to pay a current cash dividend may declare a scrip dividend. That is the corporation issues promissory notes (called scrip) requiring the Corp. to pay dividends at some future date.
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Retained Earnings xxx Dividends Payable (or Notes Pay.) xxx On the date of Payment: Dividends Payable xxx Interest Expense xxx Cash xxx
Stock Dividends
A stock dividend is a pro rata (proportional) distribution of additional shares of a corporations own stock to its shareholders. When a stock dividend is distributed, no corporate assets are distributed. Each stockholder maintain the same percentage of ownership as before. Stock dividend is similar to a stock split.
Stockholders' Equity (2)- Retained Earnings 39
the stock dividends are accounted for by transferring from retained earnings to contributed capital an amount equals to the fair market value of the additional shares issued.
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A Corporation with 20,000 shares outstanding declares and issues a 10% stock dividend. On the date of declaration, the stock is selling for $23 per share with a par value of $10 per share. The journal entry to recorded the stock dividend is :
Stockholders' Equity (2)- Retained Earnings 42
Date of Declaration:
Retained Earnings 46,000 C.S. To be Distributed ** Additional Paid-in Capital from Stock Dividend
20,000
26,000
Date of Issuance:
20,000
20,000
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Similar to example 1 except that the stock dividend increases from 10 % to 40% of the shares outstanding:
Date Declaration:
* An alternative account is retained earnings. If R/E is debited, the accounting standard does not prevent the capitalization of a larger amount per share.
Stockholders' Equity (2)- Retained Earnings 44
80,000 80,000
Reason of debiting paid-in capital rather than R/E for large stock dividends: to prevent transferring earned capital to invested capital.
Stockholders' Equity (2)- Retained Earnings 45
Fractional Shares
A stock dividend or a stock split often results in some shareholders being entitled to fractions of whole shares (fractional shares). Cash payments (based on the fair value at declaration) are made to shareholders with fractional shares.
Stockholders' Equity (2)- Retained Earnings 46
Liquidating Dividends
Liquidating dividends are a return of contributed capital to stockholders rather than a distribution of earned capital (i.e., R/E). This may occur in the case of insolvency and assetsa are distributed to stockholders. The liquidating portion of the dividend is debited to Additional Paid-in Capital.
a. assets which are not subject to a superior claim by creditors.
Stockholders' Equity (2)- Retained Earnings 47
48
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An appropriation (or restriction) of retained earnings is that the board of directors has "earmarked" a portion for the retained earnings (the appropriated amount) for a designated purpose. This appropriated amount is not available for dividends.
Stockholders' Equity (2)- Retained Earnings 51
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Example
Retained Earnings 2,000 Retained Earnings: Appropriated for Treasury Stock 2,000 After the treasury stock is reissued, the board of directors would cancel the appropriation: R/E Appropriated for Treasury stock 2,000 Retained earnings 2,000
Stockholders' Equity (2)- Retained Earnings 54
Note: R/E are restricted regarding dividends in the amount of $3,000, the cost of the Stockholders' stock. Retained Earnings treasury Equity (2)-
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Statement of Changes in Stockholders Equity for Year Ended December 31, 20x5
Common Stock Explanation Balances, 1/1/95 Issued for cash Reissued treaury stock Issued for exercise of stock options Compensation expense for stock options Compensation cost for new stock options Unrealized gain from valuation of SAS Net income Cash dividends Balances, 12/31/95 11,400 57,000 197,400 5,000 14,600 (11,000) Shares Issued 10,000 1,100 Par Value 50,000 5,500 Additional Paid-in Capital Common Stock Accum. Other Retained Earnings 322,000 Treasury Stock (Cost) (7,500) Common Treasury Option Deferred Compre. Stock Stock Warrants Compensation Income 170,000 22,000 2,300 12,200 (8,400) 10,000
4,500
700
3,300
(3,300)
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Quasi-Reorganization
A quasi-reorganization is primarily an accounting procedure, that involves a revaluation of corporate assets and liabilities, and a realignment of the corporate capital structure to enable the corporation to have a fresh start toward financial solvency and profitability.
Stockholders' Equity (2)- Retained Earnings 59
Quasi-Reorganization :(contd.)
The adjustment procedures are: 1. The Corp. reports to the stockholders with the restatements proposed and obtains the stockholders formal consent. 2. The Corp. presents a B/S as of the date of readjustment in which the assets and liabilities are reported at their market values.
Quasi-Reorganization :(contd.)
The adjustment procedures (contd.): 3. Any amount written off is first charged against retained earnings and then against additional paid-in capital. 4. The Corp. begins its fresh start with a zero retained earnings balance.
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Quasi-Reorganization :(contd.)
1. A write-down of the assets to their market value, with the loss debited to R/E; 2. An increase of additional paid-in capital accomplished by a decrease in the parvalue of the capital stock; 3. The elimination of the R/E deficit by a reduction of the additional paid-in capital.
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Example:
Quasi-Reorganization :(contd.)
CMG Corp.'s property and equip. are determined to have a combined market value of $92,000 rather than the book value of $140,000. Its Inventories and A/R are overvalued by $8,000 and $4,000, respectively. The board of directors, with stockholders and the state's approval, has authorized a reduction in par value of $6 per share. CMG has a deficit of $50,000 prior to the quasi-reorganization.
Stockholders' Equity (2)- Retained Earnings 63
Example:(Contd.)
Quasi-Reorganization :(contd.)
1. To write down the fixed assets to market value: Retained Earnings 48,000 Accu. depreciation 48,000
2. To write down the current assets: Retained earnings 12,000 Inventory 8,000 Accounts Receivable 4,000
Stockholders' Equity (2)- Retained Earnings 64
Example:(Contd.)
Quasi-Reorganization :(contd.)
3. To reduce the par value of stock Common Stock, $10 par 150,000 Common Stock, $4 Par 60,000 Additional Paid-in Capital 90,000
4. To eliminate the R/E Deficit:
Additional Paid-in Capital 110,000 Retained Earnings* 110,000 * 50,000 (the deficit) +48,000+12,000
Stockholders' Equity (2)- Retained Earnings 65
30,000 (50,000)
170,000
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Total assets
Additional paid (108,000) in capital Retained earnings (see note) Total liabilities and stockholders' 110,000 equity $
10,000
110,000
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