Income and Changes in Retained Earnings Chapter 12 McGraw-Hill/Irwin PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright 2012 The McGraw-Hill Companies, Inc.
Reporting the Results of Operations Information about net income can be divided into two major categories Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income. Income from continuing operations. 1. Results of discontinued operations. 2. Impact of extraordinary items. 12-2
Matrix, Inc. Income Statement For the Year Ended December 31, 2011 Net Sales $ 9,000,000 Cost of goods sold 4,000,000 Gross margin $ 5,000,000 Operating expenses: Selling expenses $ 1,500,000 General & admin. exp. 920,000 Loss on settlement of lawsuit 80,000 Income taxes 750,000 3,250,000 Income from continuing operations $ 1,750,000 Discontinued operations (175,000) Extraordinary items (52,500) Net income $ 1,522,500 This tax expense does not include effects of unusual, nonrecurring items. These unusual, nonrecurring items are each reported net of taxes. 12-3
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 Income/Loss from operating the segment prior to disposal. Income/Loss on disposal of the segment. 12-4
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. 12-5
Discontinued Operations During 2011, 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? 12-6
Discontinued Operations Loss on segment operations $ (150,000) Less: Tax benefits ($150,000 30%) 45,000 Net loss $ (105,000) Loss on disposal of assets $ (100,000) Less: Tax benefits ($100,000 30%) 30,000 Net loss $ (70,000) 12-7
Discontinued Operations Income Statement Presentation: Income from continuing operations $ 1,750,000 Discontinued operations: Loss on operations (net of tax benefit of $45,000) (105,000) Loss on disposal of assets (net of tax benefits of $30,000) (70,000) Earnings before extraordinary item $ 1,575,000 12-8
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. 12-9
Extraordinary Items During 2011, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its manufacturing plants in Chicago. 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 2011 income statement? 12-10
Extraordinary Items Extraordinary Loss $ (75,000) Less: Tax Benefits ($75,000 30%) 22,500 Net Loss $ (52,500) Income Statement Presentation: Earnings before extraordinary item $ 1,575,000 Extraordinary Loss: Earthquake loss (net of tax benefit of $22,500) (52,500) Net income $ 1,522,500 12-11
Earnings Per Share (EPS) A measure of the company s profitability and earning power for the period. Earnings Per Share = Net Income Weighted Average Number of Shares Outstanding Based on the number of shares issued and the length of time that number remained unchanged. 12-12
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. Let s prepare a partial income statement using all this information. 12-13
Earnings Per Share (EPS) Income Statement Amounts EPS Income from continuing operations $ 1,750,000 $ 11.20 Loss from discontinued operations (175,000) (1.12) Income before extraordinary items and cumulative effect of accounting change $ 1,575,000 $ 10.08 Extraordinary loss (52,500) (0.34) Net Income $ 1,522,500 $ 9.74 * $1,750,000 156,250 * Rounded. 12-14
Earnings Per Share (EPS) If preferred stock is present, subtract preferred dividends from net income prior to computing EPS. Earnings Per Share = Net Income - Preferred Dividends Weighted Average Number of Common Shares Outstanding EPS is required to be reported in the income statement. 12-15
Cash Dividends Declared by Board of Directors. Not legally required. Creates liability at declaration. Requires sufficient Retained Earnings and Cash. 12-16
Dividend Dates Date of Declaration Board of Directors declares the dividend. Record a liability. On March 1, 2011, 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. Date Description Debit Credit Mar. 1 Retained Earnings 500,000 Dividends Payable 500,000 12-17
Dividend Dates Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. Date Description Debit Credit Apr. 1 NO ENTRY 12-18
Dividend Dates Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) April 2011 X 12-19
Dividend Dates Date of Payment Record the payment of the dividend to stockholders. Date Description Debit Credit May 1 Dividends Payable 500,000 Cash 500,000 12-20
Dividend Dates On June 1, 2011, a corporation s 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. 12-21
Dividend Dates $100 8% = $8 dividend per share On June $8 2,500 1, 2011, = $20,000 a corporation s total dividend 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. 12-22
Stock Dividends Distribution of additional shares of stock to stockholders. No change in total stockholders equity. No change in par values. All stockholders retain same percentage ownership. 12-23
Entries to Record Stock Dividends In accounting for a small stock dividend (less than 20%), the market value of the new shares is transferred from Retained Earning account to the paid-in capital accounts. This process is sometimes called capitalizing retained earnings. On June 1, Aspen Corporation has outstanding 1,000,000 shares of $1 par value common stock with a market value of $25 per share. The company declares a 5% stock dividend on this date. The dividend is distributable on July 15 to stockholders of record on June 20. Let s look at the journal entries. 12-24
Entries to Record Stock Dividends Common shares outstainding 1,000,000 Stock dividend percent 5% Additional shares issuable 50,000 Market value per share $ 25 Amount assigned to dividend $ 1,250,000 Additional shares issuable 50,000 Par value per share $ 1 Change in common stock account $ 50,000 12-25
Dividend Dates Date of Declaration Board of Directors declares the dividend. Do not record a liability. Date Description Debit Credit Jun. 1 Retained Earnings 1,250,000 Stock Dividend to be Distributed 50,000 Additional Paid-in Capital: Stock Dividend 1,200,000 50,000 shares $1 par value 12-26
Dividend Dates Ex-Dividend Date The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend. Date Description Debit Credit Jun. 20 NO ENTRY 12-27
Dividend Dates Date of Record Stockholders holding shares on this date will receive the dividend. (No entry) June 2011 X 12-28
Dividend Dates Date of Payment Record the payment of the dividend to stockholders. Date Description Debit Credit Jul. 15 Stock Dividend to be Distributed 50,000 Common Stock 50,000 12-29
Reasons for Stock Dividends Management often finds stock dividends appealing because they allow management to distribute something of perceived value to stockholders while conserving cash which may be needed for other purposes. Stockholders like stock dividends because they receive more shares, often the stock price does not fall proportionately, and the dividend is not subject to income taxes (until the shares received are sold). 12-30
Distinction between Stock Splits and Stock Dividends The difference between a stock dividend and a stock split lies in the intent of management and the related issue of 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 do not result in a change in the par value of the stock. On the other hand, stock splits result in a pro rata reduction in the par value of the stock. 12-31
Summary of Effects of Stock Dividends and Stock Splits Small Stock Dividend Large Stock Dividend Stock Splits Total Stockholders' No Effect No Effect No Effect Equity Common Stock Increases Increases No Effect Paid-in Capital Increases No Effect No Effect Retained Earnings Decreases Decreases No Effect Number of Shares Outstanding Par Value per Share Increases Increases Increases No Effect No Effect Decreases 12-32
Prior Period Adjustments The correction of an error identified as affecting net income in a prior period. Adjust retained earnings retroactively. The adjustment should be disclosed net of any taxes. 12-33
Statement of Retained Earnings with Prior Period Adjustment 12-34
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. 12-35
Comprehensive Income Normally, there are 3 ways that financial position can change. Issuance of new shares of stock. Net Income or Net Loss Payment of Dividends GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments. 12-36
Comprehensive Income GAAP requires that unrealized items that are normally reported on the balance sheet be added back to compute Comprehensive Income. The accumulated amount of changes affecting Comprehensive Income is reported in equity. There are 3 options for reporting Comprehensive Income. As a second Income Statement. Combined with Net Income on the Income Statement. As an element of Stockholders Equity. 12-37
Statement of Stockholders Equity This is a more inclusive statement than the statement of retained earnings. 12-38
Stockholders Equity Section of the Balance Sheet Simmons Company Stockholders' Equity Captial Stock: Common Stock - $10 par value; 50,000 shares authorized; 30,000 shares issued and outstanding $ 300,000 Preferred Stock - $100 par value; 1,000 shares authorized; 500 shares issued and outstanding 50,000 Additional paid-in capital From issuance of common stock 375,000 From issuance of preferred stock 10,000 Total paid-in capital 735,000 Retained earnings 116,500 Total stockholders' equity $ 851,500 12-39
End of Chapter 12 12-40