Retained Earnings, Treasury Stock, and the Income Statement

1
Retained Earnings, Treasury Stock, and the Income
Statement

• Chapter 14

2
Retained Earnings

• Accumulates income that has been retained in the
  business (that is, not paid out in dividends to
  stockholders) over life of business.
• All net income minus net losses minus dividends
• Negative balance in Retained Earnings - deficit
• Not a fund of cash

3
Objective 1

• Account for stock dividends.

4
Stock Dividend

• Proportional distribution of corporations own
  stock to shareholders (10)
• Does not change total stockholders equity
• Transfer of retained earnings to contributed
  capital

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Entries for Stock Dividend

• Small
• Distribution is lt 25 of previously outstanding
  shares.
• Debit retained earnings for market value of
  shares to be distributed

• Large
• Distribution is gt 25 of previously outstanding
  shares.
• Debit retained earnings for par or stated value
  of shares.

6
Small Stock Dividend Example

• San Diego Company, with 300,000 shares of 2 par
  value common stock outstanding, declares a 15
  stock dividend when the shares are trading at 20.

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Small Stock Dividend Example

• How much stock do the shareholders receive?
• 300,000 15 45,000 shares

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Small Stock Dividend Example
Dec 31 Retained Earnings
900,000
Common stock 90,000 Paid in capital in excess
of par, common 810,000 15 stock dividend
distributed
USE MARKET VALUE 45,000 shares x 20
USE PAR Common stock 45,000 shares x 2
9
Large Stock Dividend Example

• San Diego Company, with 300,000 shares of 2 par
  value common stock outstanding, declares a 40
  stock dividend when the shares are trading at
  20.

10
Large Stock Dividend Example

• How much stock do the shareholders receive?
• 300,000 40 120,000 shares

11
Large Stock Dividend Example
Dec 31 Retained Earnings
240,000
Common stock 240,000 40 stock dividend
distributed
USE PAR 120,000 shares x 2
12
Stock Split Example

• San Diego Company had 500,000 shares of 10 par
  common stock authorized and 100,000 issued. A
  5-for-1 stock split was declared.
• After the split, how many shares are
• Authorized?
• Issued?
• What is the par value per share?

500,000 x 5 2,500,000
100,000 x 5 500,000
10 5 2
Why do companies perform Stock Splits???
13
Stock split

• No formal entry is made, but a memo entry is
  prepared in the journal.

Dec 31 Memo Called in the outstanding 10
par common stock and distributed 5 shares of 2
par (10/5) common stock for each old share.
Now 500,000 shares are outstanding.
14
Objective 2

• Distinguish stock splits from stock dividends.

15
Similarities Between StockSplits and Stock
Dividends

• Both increase number of shares of stock owned per
  stockholder.
• Neither type of income creates taxable income for
  investor.

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Differences Between StockSplits and Stock
Dividends

• Stock Dividend
• shifts amounts from retained earnings to paid-in
  capital.
• par value per share remains unchanged.

• Stock Split
• affects no account balance.
• Changes par value
• Increases number of shares of stock authorized,
  issued, and outstanding.

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Objective 3

• Account for treasury stock.

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Treasury Stock...

• Shares that a company has issued and later
  reacquired
• Purchasing treasury stock decreases assets and
  stockholders equity

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Purchasing Treasury Stock

• On May, 8, 2002, Whitt, Inc. purchased 2,000 of
  its own shares of stock in the open market for
  8,000.

May 8 Treasury stock, common 8,000 Cash 8
,000
Keep track of the cost per share 8,000 / 2,000
4
20
Selling Treasury Stock at Cost

• On June 30, 2002, Whitt sold 100 shares of its
  treasury stock for 4 per share.

Jun 30 Cash 400 Treasury stock, common 400
21
Selling Above Cost

• On July 19, Whitt sold an additional 500 shares
  of its treasury stock for 8 per share.

Jul 19 Cash 4,000 Treasury stock,
common 2,000 Paid in capital-treasury
stock 2,000
500 X 4 original cost
22
Selling Below Cost

• On August 27, Whitt sold an additional 400 shares
  of its treasury stock for 1.50 per share.

Aug 27 Cash 600 Paid in capital treasury
stock 1,000 Treasury stock, common 1,600
400 X 4 original cost
23
Retirement of Stock...

• Decreases outstanding stock
• Retired shares cannot be reissued
• There is no gain or loss on retirement

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Objective 4

• Report restrictions on retained earnings.

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Restrictions on Retained Earnings

• Reported in notes to financial statements
• Appropriations are restrictions on retained
  earnings that are recorded by formal journal
  entries

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Objective 5

• Analyze a complex income statement.

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Reporting Income Information

• Should help to predict how the company will
  perform in the future
• Items that are material in amount, but are not
  typical of regular operations, reported
  separately from continuing operations
• See page 555

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Income from continuing operations

• Measures profitability of the ongoing operations
• Useful for making projections about future
  earnings

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Special Items

• Reported after income from continuing operations
• Discontinued operations
• Extraordinary gains and losses
• Cumulative effect of an accounting change NO
  LONGER REPORTED ON THE INCOME STATEMENT!!!

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Discontinued Segment

• Segments of a business that have been sold
• Two parts reported in this section
• Income or loss from operations of business from
  beginning of year to date of disposal
• Gain or loss on disposal of the assets of the
  segment
• Reported net of the income tax effect

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Extraordinary Items

• Both unusual and infrequent.
• Unusual in nature abnormal and only
  incidentally related to customary activities
• Infrequent in occurrence not reasonably
  expected to happen in the foreseeable future
• Reported net of their tax effect.
• Accounting rules specify extraordinary items.

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Extraordinary Items

• Extraordinary items include expropriations.
• May include losses due to natural disasters.
• hurricane
• flood
• fire

33
Changes in Accounting Methods

• Adoption of a newly required accounting standard
• Changing accounting methods
• Per FASB, it is now recorded as a Prior Period
  Adjustment, adjusting the retained earnings
  balance.

34
Earnings Per Share
Net income - Preferred dividends
Weighted-average common shares
outstanding
35
Earnings Per Share Example

• On January 1, San Diego Company had 100,000
  common shares outstanding.
• On April 1, the company purchased 15,000 treasury
  shares.
• On September 1, they issued 50,000 new shares.
• Income for the year was 135,000.
• What are the earnings per share?

36
Earnings Per Share Example
No. of Shares Fraction
Weighted Outstanding of Year
Average
100,000 3/12 25,000
85,000 5/12 35,417 135,000 4/12
45,000 Total 105,417
EPS 135,000 105,417 1.28
37
Earnings Per Share and Preferred Stock

• Subtract preferred dividends from income
  subtotals (income from continuing operations,
  income before extraordinary items, and net
  income) in computation of EPS
• Preferred dividends are not subtracted from
  income or loss from discontinued operations, or
  from extraordinary gains or losses

38
Earnings Per Shareand Preferred Stock

• Corporations with complex capital structures
  present two sets of EPS amounts.
• EPS based on outstanding common shares (basic
  EPS)
• EPS based on outstanding common shares plus the
  number of additional common shares that would
  arise from conversion of the preferred stock

39
Prior Period Adjustments...

• Corrections to beginning balance of Retained
  Earnings for errors of an earlier period.
• Correcting entry includes a debit or credit to
  Retained Earnings for error amount.
• Also includes debit or credit to the asset or
  liability account that was misstated.

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Statement of Retained Earnings

• See page 559

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Objective 6

• Prepare a Statement of Stockholders Equity.

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Statement ofStockholders Equity

• More comprehensive than statement of retained
  earnings
• Reports changes in all categories of equity

43
Statement of Stockholders Equity

• See page 560