Chapter 20 Corporate Accounting: Earnings and Distribution Net income of a corporation and corporate income taxes Cash dividends Stock dividends Stock splits Appropriations of retained earnings Retained Earnings Statement 1
Net Income/Loss of A Corporation Net Income AKA net loss The bottom line of the income statement for every form of business Income Summary account (after closing revenue and expenses) Credit balance = net income Debit balance = net loss For a corporation, the net income or net loss is closed to the Retained Earnings account. The net income of a corporation is calculated in the same way as that of a proprietorship or a partnership. 2
Example Assume on Dec. 31, 20X2, Ace Trucking, Inc. reports a net income of $72,500. Ace would record the following entry to close net income into the Retained Earnings account: 20X2 Dec. 31 Income Summary 72,500 Retained Earnings 72,500 Assume on Dec. 31, 20X2 Ace Trucking, Inc. reports a net loss of $40,000. Ace would report the following entry to close net loss into the Retained Earnings account: 20X2 Dec. 31 Retained Earnings 40,000 3 Income Summary 40,000
Corporate Income Tax The corporate income tax rate is a progressive rate; that is, the higher the income, the higher the tax rate. 4 Assume taxable income is $450,000. Corporate income tax would be calculated as following, using the corporate income tax rates: $ 50,000.15 = $ 7,500 25,000.25 = 6,250 25,000.34 = 8,500 235,000.39 = 91,650 115,000.34 = 39,100 Total Tax = $153,000
Paying Income Taxes: Corporations Pay-as-you-go Estimate annual income tax expense Make four quarterly payments April 15 June 15 September 15 December 15 Any tax still owed at year-end is accrued on Dec. 31 and must be paid by March 15 of the following year. 5
Example: Paying Income Tax Assume Ace Trucking estimates income taxes for 20X1 to be $9,000. At Dec. 31, 20X1, Ace determines its total income tax for 20X1 to be $10,000. Ace records the following journal entries during 20X1 and its final tax payment for 20X1 taxes on Mar. 15, 20X2. 20X1 Apr. 15 Income Tax Expense 2,250 Cash 2,250 Jun. 15 Income Tax Expense 2,250 Cash 2,250 6 Sep. 15 Income Tax Expense 2,250 Cash 2,250
Example: Paying Income Tax (continued) 20X1 Dec. 15 Income Tax Expense 2,250 Cash 2,250 Dec. 31 Income Tax Expense 1,000 Income Tax Payable 1,000 20X2 Mar. 15 Income Tax Payable 1,000 Cash 1,000 7
Cash Dividends Dividends The distribution of corporate earnings Investors in corporations buy stock with one basic goal in mind to receive a return on their investment This goal can be accomplished in two ways: Stock grows in value, allowing investors to resell the stock for a gain Stockholders to receive a share of the corporation s earnings 8 The most common form of dividend Before a cash dividend can be declared and paid, three things are needed: Sufficient retained earnings above the legal capital requirement of the company Sufficient cash above working capital needs Formal action by the board of directors
Dates Associated with a Cash Dividend 9 Date of Declaration The date the board of directors formally declares that a dividend will be paid Date of Record The date as of which the ownership of shares is established Date of Payment The date that dividend checks are mailed to stockholders of record Many corporations maintain a constant dividend policy. IBM, for example, normally pays dividends on the 10th of March, June, September and December.
Journal Entries for Cash Dividends On Jan. 15, 20X1, the board of directors of Hudson Corporation declares a $2 cash dividend for common stockholders of record on Jan. 31, to be paid on Feb.15. Hudson has 10,000 shares of $10 par common stock outstanding. Journal entries are required on Jan. 15, 20X1 and on Feb. 15, 20X1. No journal entry is required on Jan. 31, date of record. 20X1 Jan. 15 Cash Dividends 20,000 Dividends Payable 20,000 Feb. 15 Dividends Payable 20,000 10 Cash 20,000
Dividends on Cumulative Preferred Stock Assume Bonner Corporation has outstanding 5,000 shares of $100 par, 10% cumulative preferred stock and 50,000 shares of $5 par common stock. 11
Stock Dividends A proportional distribution of additional shares of a company s own authorized stock to its stockholders. Distributed on a pro rata basis Additional shares of stock are issued in proportion to the number of shares owned by each present stockholder. For example, if a corporation declares a 10% stock dividend and an investor currently owns 100 shares, the investor would receive an additional 10 shares of stock. Example On Jul. 2, 20X1, Hudson Corporation declares a 10% common stock dividend to common stockholders of record as of Aug. 10, to be distributed on Sep. 1. Hudson has 10,000 shares of $10 par common stock outstanding. Hudson s common stock is current selling for $18 per share. Journal entries are required on Jul. 2, 20X1, and on Sep. 1, 20X1. 12
Example: Stock Dividends No journal entry is required on Aug. 10, date of record. On date of declaration, the Stock Dividends account is debited for the new shares issued times the current selling price of the stock. The Common Stock Dividends Distributable account is credited for the par value of the new shares issued. Paid-in Capital in Excess of Par Value-Common is credited for the difference. 20X1 Jul. 2 Stock Dividends 18,000 Common Stock Dividends Distributable 10,000 Paid-in Capital in Excess of Par-Common 8,000 13 Sep. 1 Common Stock Dividends Distributable 10,000 Common Stock 10,000
Small Stock Dividend Versus Large Stock Dividend Small Stock Dividend A dividend that distributes less than 25% of the number of shares previously outstanding Large Stock Dividend A dividend that distributes 25% or more of the number of shares previously outstanding The Stock Dividends account is debited for the par value of the number of shares issued, not the current market value 14
Stock Splits Corporations sometimes call in their stock and issue two, three, or more shares in place of each of the shares previously held by the stockholders. This process is called a stock split. Usually declared to reduce the market price per share, thereby making the stock easier for investors to afford. When a company splits its stock: 15 The number of shares in the marketplace is increased. The share price of the stock is reduced. The number of a company s unissued shares is also increased proportionate to the split.
Example: Stock Splits Hudson Corporation currently has outstanding 50,000 shares of $10 par common stock outstanding. Hudson Corporation declares a 2-for-1 split. After the stock split, Hudson Corporation has 100,000 shares of $5 par common stock outstanding. A memorandum entry may be prepared to record the stock split. 16
Appropriation of Retained Earnings We have learned that corporations must have sufficient retained earnings before dividends can be declared. Even with sufficient retained earnings, the board may want to limit the amount of retained earnings available for dividends. The board may vote to earmark or restrict a part of the retained earnings for a specific purpose, referred to as an appropriation of retained earnings. Assume the board of directors of Tagen Company decide to build a new building. Also assume on Mar. 1, 20X2, Tagen Company s board of directors votes to restrict retained earnings at a rate of $60,000 per year for the next 5 years. 17
Example: Restricted Retained Earnings Tagen Company would record the following journal entry each year: 20X2 Mar. 1 Retained Earnings 60,000 Retained Earnings Appropriated for Building 60,000 The transaction does not change the company s total retained earnings nor set up a cash fund. The journal entry only limits the amount of retained earnings available for dividends. 18
Balance Sheet with Appropriated Retained Earnings 19
Retained Earnings Statement A corporation prepares a retained earnings statement as opposed to a statement of owner s equity for a proprietorship or partnership. Shows the changes in retained earnings for a period of time: (simple) 20
Complex Retained Earnings Statement 21