CHAPTER 14
CORPORATIONS: DIVIDENDS, RETAINED
EARNINGS, AND INCOME REPORTING
LEARNING OBJECTIVES
1. EXPLAIN HOW TO ACCOUNT FOR CASH DIVIDENDS.
2. EXPLAIN HOW TO ACCOUNT FOR STOCK DIVIDENDS
AND SPLITS
CHAPTER REVIEW
Dividends
1. (L.O. 1) A dividend is a distribution by a corporation to its stockholders on a pro rata (proportional)
basis. Dividends may be in the form of cash, property, scrip, or stock.
2. A cash dividend is a pro rata distribution of cash to stockholders. For a corporation to pay a cash
dividend, it must have (a) retained earnings, (b) adequate cash, and (c) declared dividends.
3. Three dates are important in connection with dividends:
a. Declaration date—the date on which the board of directors formally declares a cash dividend
and the liability is recorded.
Stock Dividend
5. (L.O. 2) A stock dividend is a pro rata (proportional to ownership) distribution of the corporation’s
own stock to stockholders. A stock dividend results in a decrease in retained earnings and an
increase in paid-in capital. At a minimum, the par or stated value must be assigned to the dividend
shares; in most cases, however, fair value is used.
6. When the fair value of the stock is used, the following entry is made at the declaration date:
Stock Dividends ………………………………………………………………………… XXX
Common Stock Dividends Distributable ………………………………… XXX
Paid-in Capital in Excess of Par—Common Stock …………………… XXX
Stock Split
8. A stock split involves the issuance of additional shares of stock to stockholders according to their
percentage ownership.
b. A stock split has no effect on total paid–in capital, retained earnings, or total stockholders’ equity.
c. It is not necessary to formally journalize a stock split.
Retained Earnings
9. Retained earnings is net income that is retained in the business. The balance in retained earnings
is part of the stockholders’ claim on the total assets of the corporation.
10. In some cases there may be retained earnings restrictions that make a portion of the balance
currently unavailable for dividends. Restrictions result from one or more of the following causes:
11. A prior period adjustment is the correction of a material error in reporting net income in previously
issued financial statements. The correction is:
12. Many corporations prepare a retained earnings statement to explain the changes in retained
earnings during the year.
Stockholders’ Equity Statement
Form of Income Statement
14. (L.O. 4) The income statement for a corporation includes essentially the same sections as in a
proprietorship or a partnership. The major difference is a section for income taxes.
Earnings Per Share
15. Earnings per share (EPS) indicates the net income earned by each share of outstanding common
stock.
a. The formula for computing earnings per share is:
b. Most companies are required to report earnings per share on the income statement.
c. When there has been a change in the number of shares outstanding during the year, the
denominator in the formula becomes the weighted-average shares outstanding.
LECTURE OUTLINE
A. Dividends.
1. A dividend is a corporation’s distribution of cash or stock to its stockholders
on a pro rata (proportional) basis.
2. Dividends can take four forms:
a. Cash.
B. Cash Dividends.
1. A cash dividend is a pro rata distribution of cash to stockholders.
2. For a corporation to pay a cash dividend, it must have the following:
a. Retained earnings.
3. Three dates are important in connection with dividends:
a. The declaration date: the date the board of directors formally declares
(authorizes) the cash dividend and announces it to stockholders.
The company makes an entry to recognize the increase in Cash
Dividends and the increase in the liability Dividends Payable.
ACCOUNTING ACROSS THE ORGANIZATION
The decision whether to pay a dividend, and how much to pay, is a very important
management decision. From 2002–2007, many companies substantially increased
their dividends, and total dividends paid by U.S. companies hit record levels.
What factors must management consider in deciding how large a dividend to pay?
Answer: Management must consider the size of its retained earnings balance,
the amount of available cash, its expected near-term cash needs, its
C. Stock Dividends.
1. A stock dividend is a pro rata (proportional to ownership) distribution of the
corporation’s own stock to stockholders.
2. A stock dividend results in a decrease in retained earnings and an increase
in paid-in capital. Unlike a cash dividend, a stock dividend does not decrease
total stockholders’ equity or total assets.
D. Stock Splits.
1. A stock split, like a stock dividend, involves issuance of additional shares
to stockholders according to their ownership percentage.
2. A stock split results in a reduction in the par or stated value per share.
E. Retained Earnings.
1. Retained earnings is net income that a company retains for use in the
business and is part of the stockholders’ claim on the total assets of the
corporation.
F. Retained Earnings Restrictions.
1. Retained earnings restrictions make a portion of the retained earnings
balance currently unavailable for dividends.
2. Restrictions result from one or more of the following causes:
a. Legal restrictions. Many states require a corporation to restrict retained
earnings for the cost of treasury stock purchased.
3. Companies generally disclose retained earnings restrictions in the notes
to the financial statements.
G. Prior Period Adjustments.
1. A prior period adjustment is the correction of an error in previously issued
financial statements.
H. Retained Earnings Statement.
1. The retained earnings statement shows the changes in retained earnings
during the year. The company prepares the statement from the retained
earnings account.
I. Statement Presentation and Analysis.
1. A comprehensive stockholders’ equity section includes all stockholders’
equity accounts. It consists of two sections: paid-in capital and retained
earnings. Instead of presenting a detailed stockholders’ equity section in
2. The return on common stockholders’ equity measures profitability and
shows how many dollars of net income the company earned for each dollar
J. Corporation Income Statement.
1. Income statements for corporations are the same as the statements for
proprietorships or partnerships except for the reporting of income taxes.
Corporations report income tax expense in a separate section of the
corporation income statement, before net income.
K. Earnings Per Share.
1. A convenient measure of earnings is earnings per share (EPS), which
2. The formula for computing earnings per share is net income available to
common divided by the weighted-average of common shares
outstanding during the period.
3. Preferred stock dividends.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1. The cumulative effect of the declaration and payment of a cash dividend is to decrease
both stockholders’ equity and total assets.
True False
2. A stock split does not have any effect on total paid-in capital, retained earnings, or total
stockholders’ equity.
True False
3. A stock dividend results in a decrease in retained earnings and a decrease in total stockholders’
equity.
True False
4. Earnings per share is reported for both common and preferred stock.
True False
5. Income tax expense is reported in a separate section of the corporation income statement
before net income.
True False
6. The return on common stockholders’ equity shows how many dollars of net income were
earned for each dollar invested by stockholders.
True False
7. A prior period adjustment always includes a credit to Retained Earnings.
True False
8. A restriction on retained earnings is described as a cash fund established for a specific
future purpose.
True False
9. The accounting effects of a restriction on retained earnings is limited entirely to the retained
earnings section of stockholders’ equity.
True False
10. Three important dates when cash dividends are involved are: date of declaration, date of
record, and date of payment.
True False
Multiple Choice
1. A company had outstanding 80,000 shares of $10 par value common stock. During the
period a 10% stock dividend was declared and distributed. The market price was $25 a
share. As a result of this stock dividend, retained earnings should increase (decrease) by
an amount of
a. $(120,000).
b. $( 80,000).
c. $(200,000).
d. $80,000.
2. For a corporation to pay a cash dividend, it must have all of the following except
a. retained earnings.
b. net income.
c. adequate cash.
d. a declaration of dividends.
3. Which one of the following decreases total stockholders’ equity?
a. Stock splits.
b. Small stock dividends.
c. Large stock dividends.
d. Cash dividends.
4. A prior period adjustment
a. may be recorded for a computational error of a prior period that was discovered this
period.
b. is disclosed in the balance sheet.
c. may be recorded for an additional tax assessment for a prior year.
d. may be recorded for a lawsuit that was initiated two years ago but was settled this year.
5. The return on common stockholders’ equity is computed by dividing
a. net income by ending common stockholders’ equity.
b. net income by average common stockholders’ equity.
c. net income less preferred dividends by ending common stockholders’ equity.
d. net income less preferred dividends by average common stockholders’ equity.
ANSWERS TO QUIZ
True/False
1. True 6. True
2. True 7. False
Multiple Choice
1. c.
2. b.