Changes in

Retained Earnings

CHAPTER 12
FINANCIAL MANAGEMENT
WILLIAMS .JR
Financial indicators
such as sales are
Investors evaluate it
to make investment
decisions
important

Market price of
Why? common stock Capital
Gain

Cash Dividend
 Developing useful predictive
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 Income
Useful statement for investorstatement
decision

Two types of activitiesNot

that Impact the information Regular
regular

Discontinue Extraordinar Continuous

The further
d operation
Breakdown
y Item operations
CONTINUING OPERATIONS
The subtotal income from
continuing operations
measures the profitability of
the ongoing operations. This
subtotal should be helpful in
making predictions of the
company’s future earnings
if we predict no significant
change in the profitability of
its retail stores, we would
expect Farmer Corporation
to earn a net income of
approximately $700,000
next year.
 DISCONTINUED OPERATIONS
When management enters
into a formal plan to sell or
Two Parts of
discontinue a segment of Discontinuou
the business, the results of
that segment’s operations s operations
are shown separately in the
income statement. Excluding
that part of the business that Gain/loss
Gain/loss to
will no longer be part of the
prior to
company’s operations the sale of
enables users of the financial selling
statements to better evaluate business
the performance segment
Statement containing irregular
items
EXTRAORDINARY ITEMS
 When a gain or loss qualifies
The second category of as an extraordinary item, it
irregular events requiring appears after the section on
disclosure in a separate discontinued operations (if
section of the income any), following the subtotal
statement is extraordinary
income before extraordinary
items. An extraordinary
item is a gain or loss that items. This subtotal is
is (1) unusual in nature necessary to show investors
and (2) not expected to what the net income would
recur in the foreseeable have been if the extraordinary
future gain or loss had not occurred.
 Extraordinary items are shown
net of any related income tax
effects.
Unusual gains and losses

Example
Labor strike
Gains that are not
Unusual gains and normally recurring
loses But do not classify
as extraordinary
Restructuring
operation
 Earning per share
The of the most widely used
To compute earnings per
accounting statistics is earnings
share, the common
per share on common stock.
stockholders’ share of
Investors who buy or sell stock in
the company’s net
a corporation need to know the
income is divided by the
annual earnings per share. Stock
average number of
market prices are quoted on a
common shares
per-share basis. If you are
outstanding. Earnings per
considering investing in a
share applies only to
company’s stock at a price of $50
common stock; preferred
per share, you need to know the
stockholders have no
earnings per share and the
claim to earnings beyond
annual dividend per share to
the stipulated preferred
decide whether this price is
stock dividends.
reasonable.
 Preferred Dividends and Earnings
per Share
When a company has
preferred stock outstanding,
the preferred stockholders
participate in net income
only to the extent of the
preferred stock dividends.
All publicly
To determine the earnings owned
applicable to the common stock,
we first deduct from net income
corporations
the amount of current year are required
preferred dividends. The annual to present
dividend on cumulative earnings per
preferred stock is always
deducted, even if not declared share figures in
by the board of directors for the their income
current year statements
Other Transactions Affecting
Retained Earnings
Liquidating Stock dividend
Cash Dividend date dividend
Dividend
Some tock dividend is a
A term
profitable 1. Date of used to describe
corporations do declaration. liquidating a distribution of
not pay dividend additional shares of
2. Ex- occurs whenstock to a company’s
dividends stockholders in
dividend a corporation proportion to their
1. Retained
earnings
date pays a present holdings
dividend that An important
2. An adequate 3. Date of exceeds the distinction exists
cash position record between a cash
balance in dividend and a stock
3. Dividend 4. Date of the Retained dividend. A cash
action by the payment Earningsdividend reduces both
assets and
board of account stockholders’ equity.
director In a stock dividend,
Result of however, no assets
liquidation or are distributed but.
downscaling ownership in the
corporation is no
larger than before
Entries for stock dividend

• In accounting for relatively small stock dividends (say, less than 20 percent), the market
value of the new shares is transferred from the Retained Earnings account to the paid-in
capital accounts. This process sometimes is called capitalizing of retained earning

Reasons for stock dividend

• distribute something of perceived value to stockholders while conserving cash

• receive more shares, often the stock price does not fall proportionately, and the dividend
is not subject to income taxes
• Large stock dividend keep prices in trading range

Stock split vs stock dividend

• The difference between a stock dividend and a stock split lies in the intent of
management and the size of the distribution. A stock dividend usually is intended to
substitute for a cash dividend and is small enough that the market price of the stock is
relatively unaffected. Stock dividends typically increase the number of outstanding shares
by 2, 5, or 10 percent. Stock splits, on the other hand, are intended to reduce the market
price of the stock to bring it down to a desired trading range. Stock splits typically
represent much larger increases in the number of outstanding shares, such as 100
percent (2:1 split) or 200 percent (3:1 split).
 STATEMENT OF RETAINED
EARNINGS
T he term retained earnings refers to the
portion of stockholders’ equity derived from
profitable operations. Retained earnings is
increased by earning net income and is
reduced by incurring net losses and by the
declaration of dividends
Prior period
adjustment
Restriction
• Some portion of retained
• On occasion, a company
earnings may be
may discover that a restricted because of
material error was made various contractual
in the measurement of agreements
net income in a prior year
Comprehensive income

What is
Ways of
comprehensiv Impact
showing
e income ?

Second income
statement

Increase in equity if
the value goes up
comprehensive income Single income
is recording of statement
revaluation of
investments that are
available for sale
Decrease in equity
Changes in
if the value goes
stockholder’s equity
down
 Statement of stockholder’s equity
Issuance of common stock for
$260,000 (resulting in an
increase in both common stock
and additional paid-in capital).
Many corporations
expand their statement
• Conversion of shares of
of retained earnings to
preferred stock into common
show the changes Other
stock at $100,000, resulting in a
during the year in all transactions
decrease in 5 percent
of the stockholders’
convertible preferred stock and
equity accounts. This
an increase in common stock
expanded statement,
and additional paid-in capital.
called a statement of
stockholders’ equity
• Purchase of $47,000 of
treasury stock, increasing the
amount of treasury stock and
decreasing the total of
stockholders’
Conclusion

 We discussed various aspects of stockholders’ equity, focusing

first on paid-in capital in Chapter 11 and then on earned capital
in Chapter 12. These discussions complete our detailed coverage
of assets, liabilities, and stockholders’ equity, which began in
Chapter 7 and included financial assets, inventories, plant and
intangible assets, liabilities, and, finally, stockholders’ equity.
While these chapters generally follow a balance sheet
organization, in Chapter 12 we also covered the income
statement, including the presentation of irregular income items
and earnings per share.