INCOME AND CHANGES IN RETAINED EARNINGS

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Chapter12
INCOME AND CHANGES IN RETAINED EARNINGS
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Learning Objective
To describe how irregular income items, such as
discontinued operations and extraordinary items,
are presented in the income statement.
LO1
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Reporting the Results of Operations
Information about net income can be divided into
two major categories
Income from continuing operations.
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This tax expense does not include effects of
unusual, nonrecurring items.
These unusual, nonrecurring items are each
reported net of taxes.
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Discontinued Operations
When management enters into a formal plan to sell
or discontinue a segment of the business, the
related gains and losses must be disclosed on the
income statement.
Discontinued Operations
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Discontinued Operations
When management enters into a formal plan to sell
or discontinue a segment of the business, the
related gains and losses must be disclosed on the
income statement.
A segment must be a separate line of business
activity or an operation that services a distinct
category of customers.
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Discontinued Operations
During 2007, Matrix, Inc. sold an unprofitable
segment of the company. The segment had a net
loss from operations during the period of
150,000 and a loss on the sale of its assets of
100,000. Matrix reported income from continuing
operations of 1,750,000. All items are taxed at
30. How will this appear on the income
statement?
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Discontinued Operations
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Discontinued Operations
Income Statement Presentation
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Extraordinary Items

• Material in amount.
• Gains or losses that are both unusual in nature
  and not expected to recur in the foreseeable
  future.
• Reported net of related taxes.

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Extraordinary Items
During 2007, Matrix, Inc. experienced a loss of
75,000 due to an earthquake at one of its
manufacturing plants in Nashville. This was
considered an extraordinary item. The company
reported income before extraordinary item of
1,575,000. All gains and losses are subject to
a 30 tax rate. How would this item appear on the
2007 income statement?
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Extraordinary Items - Example
Income Statement Presentation
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Lets move on to a few final topics.
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Learning Objective
To compute earnings per share.
LO2
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Earnings Per Share (EPS)
A measure of the companys profitability and
earning power for the period.
Based on the number of shares issued and the
length of time that number remained unchanged.
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Earnings Per Share (EPS)
Remember that Matrix, Inc. has income from
continuing operations of 1,750,000. The
after-tax loss from discontinued operations was
175,000 and the extraordinary loss was 52,500.
Assume that Matrix has 156,250 weighted average
shares outstanding. Prepare a partial income
statement showing the EPS for income from
continuing operations and for the other special
items.
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Earnings Per Share (EPS)
Rounded.
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Earnings Per Share (EPS)
If preferred stock is present, subtract preferred
dividends from net income prior to computing EPS.
EPS is required to be reported in the income
statement.
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Learning Objective
To distinguish between basic and diluted earnings
per share.
LO3
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Basic and Diluted Earnings per Share
If a company has convertible securities, like
convertible preferred stock outstanding, the
conversion of these securities to common stock
may dilute (reduce) earnings per share.
Diluted earnings per share reflect the impact of
the assumed conversion of the securities on
earnings.
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Price-earnings Ratio (P/E)
Often, the Price-Earnings Ratio is used to
evaluate the reasonableness of a companys stock
price.
Lets examine this further.
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Learning Objective
To account for cash dividends and stock
dividends, and explain the effects of these
transactions on a companys financial statements.
LO4
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Accounting for Cash Dividends
Declared by Board of Directors.
Not legally required.
Requires sufficient Retained Earnings and Cash.
Creates liability at declaration.
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Dividend Dates

• Date of Declaration
• Board of Directors declares the dividend.
• Record a liability.

On March 1, 2007, the Board of Directors of
Matrix, Inc. declares a 1.00 per share cash
dividend on its 500,000 common shares
outstanding. The dividend is payable to
stockholders of record on April 1, and paid on
May 1.
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Dividend Dates

• Ex-Dividend Date
• The day which serves as the ownership cut-off
  point for the receipt of the most recently
  declared dividend.

NO ENTRY
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Dividend Dates

• Date of Record
• Stockholders holding shares on this date will
  receive the dividend. (No entry)

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Dividend Dates

• Date of Payment
• Record the payment of the dividend to
  stockholders.

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Dividend Dates
On June 1, 2007, a corporations board of
directors declared a dividend for the 2,500
shares of its 100 par value, 8 preferred stock.
The dividend will be paid on July 15. Which of
the following will be included in the July 15
entry? a. Debit Retained Earnings 20,000. b.
Debit Dividends Payable 20,000. c. Credit
Dividends Payable 20,000. d. Credit Preferred
Stock 20,000.
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Accounting for Stock Dividends
Distribution of additional shares of stock to
stockholders.
All stockholders retain same percentage ownership.
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Summary of Effects of Stock Dividends and Stock
Splits
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Learning Objective
To describe and prepare a statement of retained
earnings.
LO5
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Statement of Retained Earnings with Prior Period
Adjustment
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Restrictions of Retained Earnings
If I loan your company 1,000,000, I will want
you to restrict your retained earnings in order
to limit dividend payments.
Loan agreements can include restrictions on
paying dividends below a certain amount of
retained earnings.
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Learning Objective
To define prior period adjustments, and explain
how they are presented in financial statements.
LO6
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Prior Period Adjustments
The correction of an error identified as
affecting net income in a prior period.
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Learning Objective
To define comprehensive income, and explain how
it differs from net income.
LO7
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Comprehensive Income
Normally, there are 3 ways that financial
position can change.
GAAP excludes some unrealized items from income,
such as the change in market value of
available-for-sale debt and equity investments.
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Comprehensive Income
GAAP requires that unrealized items that are
normally reported on the balance sheet be added
back to compute Comprehensive Income.
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Learning Objective
To describe and prepare a statement of
stockholders equity and the stockholders equity
section of the balance sheet.
LO8
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Statement of Stockholders Equity
This is a more inclusive statement thanthe
statement of retained earnings.
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Stockholders Equity Section of the Balance Sheet
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Learning Objective
To illustrate steps management might take to
improve the appearance of the companys net
income.
LO9
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Improving the Appearance of Income
Companies may take certain steps that are
intended to improve the appearance of its
financial performance in the financial
statements. The Securities and Exchange
Commission brought a series of enforcement
actions against certain companies for taking
these steps.
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End of Chapter 12