INTERMEDIATE ACCOUNTING 2 1st Semester, SY 2022-2023

Learning Material 12
RETAINED EARNINGS: Dividends

A. Discussion of Accounting Principles

1. Retained Earnings
 Represent the cumulative balance of the following:
a. Net income or loss for the period
b. Dividend distributions
c. Prior period errors
d. Changes in accounting policy
e. Reclassifications of some components of other comprehensive income
f. Other capital adjustments

 The IFRS term for retained earnings is accumulated profits.

 In this Learning Resource, the retained earnings account is used in succeeding illustrations.

 Be informed also that the illustrative statement of financial position and statement of changes in
equity in IAS 1 and IAS 8 still maintain the title retained earnings.

2. Kinds of retained earnings

a. Unappropriate retained earnings
b. Appropriate retained earnings

 Unappropriate retained earnings represent the portion which is free and can be declared as
dividends to shareholders.

 Appropriated retained earnings represent that portion which has been restricted and therefore is not
available for any dividend declaration.
 When the retained earnings account has a debit balance, it is called a deficit.

 A deficit is not an asset but a deduction from shareholders’ equity.

 The IFRS term for deficit is accumulated losses.

3. Dividends
 Dividends are distributions of earnings or capital to the shareholders in proportion to their
shareholdings. Dividends are broadly classified into two namely:

a. Dividends out of earnings

b. Dividends out of capital

4. Dividends out of earnings

 Legally, dividends can be declared only from retained earnings.

 If the entity has a deficit, it is illegal to pay dividends or if the entity declares dividend in excess of
the retained earnings balance, the excess is a return of capital and therefore violates the trust fund
doctrine.

 The Securities and Exchange Commission has ruled, however, that stock dividends may be declared
from premium on par value share.

 Dividend declaration is based on the decision of the board of directors of the corporation.

 When dividends are formally declared by the board of directors, three dates are essential for
accounting purposes, namely:

a. Dates of declaration is the date on which the directors authorize the payment of dividends to
shareholders.

b. Date of record is the date on which the stock abd transfer book of the corporation will be closed
fror registration.
 Only those shareholders registered as of such date are entitled to receive dividends.

No entry is required on this date but a list of the shareholders entitled to receive dividends is
made.

c. Date of payment is the date on which the dividend liability is to be paid.

5. Recognition of dividend
 Under IFRIC 17 “Distribution of noncash asset to owners”, paragraph 10, the liability to pay
dividend shall be recognized when the dividend is appropriately authorized and is no longer at the
discretion of the entity, which is the date:

a. When the dividend is declared by management or the board of directors if the local jusrisdiction
does not require futher approval.

Under Philippine jurisdiction, the declaration by the board of directors does not require further
approval.
b. When the declaration of the dividend by management or the board of directors is approved by
the relevant authority, for example, the shareholders, if the local jurisdiction requires such
approval.

 This means that the liability for dividend must be recognized on the date of declaration.

6. Dividends out of earnings

 The dividends out of earnings are usually in the form of the following:

a. Cash dividends
b. Property dividends
c. Liability dividends in the form of bond and scrip
d. Share dividends or bunos issue

7. Cash dividends
 Cash dividends are the most common type of dividend. The term dividend standing alone normally
implies the distribution of cash. Dividends may be expressed as follows:

a. A certain amount of pesos per share – for example, the dividend is P5 per share.

b. A certain percent of the par or stated value – Thus, if a 7% dividend is declared, a P200 par
value share will receive P14 as dividend.

 When cash dividends are declared, a current liability is recognized on the date of declaration by
debiting retained earnings or “dividends” and crediting dividends payable.

 The account “dividends” is used when dividends are declared during the year. Such account is
closed to retained earnings at the end of the year.

 No objection can be raised, if the dividend declared during the year is directly charged to retained
earnings.

 When the dividends declared are paid, the entry is debit dividends payable and credit cash.

8. Property dividends
 Property dividends or dividends in kind are distribution of earnings of the entity to the shareholders
in the form of noncash assets.

 The accountingfor property dividend is noe covered by IFRIC 17 as promulgated by the

International Finance Reporting Interpretations Committee.

 Property dividends are considered as “distribution of noncash assets to owners”.

 There are two accounting issues with respect to property dividends, namely:

a. Measurement of the property dividend payable.

b. Measurement of the noncash asset to be distributed as property dividend.
9. Measurement of property dividend payable
 IFRIC 17, paragraph 11, provides that an entity shall measure a liability to distribute noncash asset
as a dividend to its owners at the fair value of the asset to be distributed.

 Paragraph 13 further provides that at the end of each reporting period and at the date of settlement,
the entity shall review and adjust the carrying amount of the dividend payable with any change
recognized in equity as adjustment to the amount of distribution.

 This simply means that the dividend payable is initially recognized at the fair value of the noncash
asset on date of declaration and is increased or decreased as a result of the change in fair value of
the asset at year-end and date of settlement.

 The offsetting debit or credit is through equity or directly to retained earnings.

10. Settlement of property dividend payable

 When an entity settles the dividend payable, the difference between the carrying amount of the
asset distributed shall be recognized in profit or loss (IFRIC 17, paragraph 14).

11. Measurement of noncash asset distribution

 The classification, presentation and measurement requirements in this PFRS also apply to “a
noncurrent asset to be distributed to owners” as property dividend (PFRS 5, paragraph 5A, as
amended).

 Paragraph 15A further provides that an entity shall measure a noncurrent asset classified for
distribution to owners at the lower of carrying amount and fair value less cost to distribute.

 Accordingly, if the fair value less cost to distribute is lower than the carrying amount of the asset
at the end of the reporting period, the difference is accounted for as impairment loss.

12. Choice of either noncash or cash

 If an entity gives its owners a choice of either a noncash asset or a cash alternative, the entity shall
estimate the dividend payable by considering both the fair value of each alternative and associated
probabilities of owners selecting each alternative (IFRIC 17, paragraph 12).

 At the end of each reporting period and at the date of settlement, the entity shall adjust the dividend
payable based on the alternative chosen through equity or retained earnings.

13. Scrip dividend

 Scrip dividends are declared in the amount of P200,000 payable in six months at 12 interest. The
journal on the date of declaration is:

Retained earnings 200,000

Scrip dividends payable 200,000

 When scrip dividend are redeemed, the journal entry is:

Scrip dividend payable 200,000

Interest expense (200,000 x 12% x ½) 12,000
Cash 212,000

 A scrip is like a note which is a formal evidence of indebtedness to pay a sum of money at some
future time.

14. Bond dividend

 Dividends are declared in the amount of P1,000,000 payable in entity’s own bonds, 12%,
P1,000,000 face value. The bondd mature in five years.

a. To record the declaration of the dividends:

Retained earnings 1,000,000
Bond dividends payable 1,000,000

b. To record the issuance of the bonds in payment for the dividends:

Bond dividends payable 1,000,000
Bond payable 1,000,000
 c. To record the payment of periodic semiannual interest on the bonds:
Interest expense 60,000
Cash (1,000,000 x 12% x ½) 60,000

d. To record the redemption of the bonds on maturity date:

Bonds payable 1,000,000
Cash 1,000,000

15. Share dividend or stock dividend

 The IFRS term for share dividend is bonus issue.

 Share dividends are distributions of the earnings of the entity in the form of the entity’s own shares.

 When share dividends are declared, the retained earnings of the entity are in effect capitalized,
meaning transferred to share capital.

 The assets of the entity remain the same before and after the issuance of the share dividends.

 The share dividends create only a change in the components of the shareholders’ equity – decrease
in retained earnings but increase in share capital.

 Share dividends may be referred to as ordinary share dividends or special share dividends.

 Ordinary share dividends are dividends in terms of ordinary share given to preference shareholders
or preference share given to ordinary shareholders.

 Special share dividends are dividends in terms of ordinary share given to preference shareholders
or preference share given to ordinary shareholders.

16. Question on share dividend

 How much of the retained earnings should be capitalized?

 The IFRS does not address share dividend. Thus, guidance is based on local GAAP in accounting
for share dividend.

 If the share dividend is less than 20%, the amount charged to retained earnings is equal to the fair
value on the date of declaration.

 It is necessary that the fair value must not be lower than par or stated value. Otherwise, the amount
debited to retained earnings is equal to par or stated value.

 If the share dividend is less than 20%, it is conceived as a small share dividend because based on
empirical evidence the small share devidend does not result in a reduced market price for the
outstanding shares.

 If the share dividend is 20% or more, the par or stated value is capitalized because this is conceived
to materially effect a reduction in the share market value.

 Share dividend of 20% or more is considered as large share dividend.

17. Fraction share devidends

 When share devidends are issued, it is usually impossible to issue full shares to all of the
stockholders.

 For example, if 10% share dividend is declared, it means that a shareholder shall receive one share
for every ten shares held.

 Thus, a shareholder owning 45 shares shall be entitled to receive four full shares and a fractional
one-half share.

 With respect to the issuance of the full shares, no accounting problem is involved.

 The accounting problem is with respect to the fractional shares.

  The following steps may be taken by the entity with respect to the fractional share dividends.

a. The entity may issue warrants for the fractional shares and give the holders thereof enough time
to accumulate sufficient warrants for a full share.

b. The entity may pay cash in lieu of fractional share.

This is possible only if the source of share dividends is retained earnings.

If the source of share dividends is share premium, the cash payment is illegal.

18. Treasury shares as share dividend

 Treasury share may be declared as share dividend.

 Treasury shares may be reissued as devidends in which case most of the share shall be charged to
retained earnings.
 The declaration of treasury shares as dividend is termed as property dividend under the Philippine
Corporation Code.

 However, the authors believe that such declaration shall be accounted for as share dividend because
the entity’s obligation is not to convey noncash asset but to reissue its own share capital, and
therefore no accounting liability arises.

 Under PAS 32, treasury shares are a component of shareholders’ equity and not a financial asset.

 This is an example of economic substance of a transaction prevailing over the legal form.

19. Special cases on share dividend

 When shareholders may elect to receive cash in lieu of share dividend, the amount to be charged
to retained earnings should be equivalent to the option cash dividend.

 In a certain cases, share dividends are declared on the basis of a proposed increase in authorized
share capital, the application for which has been filled but not yet approved by SEC at the end of
the reporting period.

The proposed increase on such dividend declaration generally shall not be reflected in the statement
of financial position prior to SEC approval

These matters should be disclosed in the notes to financial statements.

If the proposed increase in authorized share capital is approved by SEC after the end of the
reporting period and the share dividends are subsequently effected before release of statements, the
new authorized share capital may be presented.

The share dividend may be shown as part of issued share capital.

However, disclosure is necessary in such case.

 In closely held entities, if share dividends are declared, retained earnings shall be capitalized only
to the extent of par value or stated value of the shares.

20. Dividends out of capital

 When capital is returned to shareholders, it is known as dividend out of capital or liquidating
dividend.

 As a rule, liquidating dividends are paid to the shareholders when the entity is dissolved and
liquidated.

 During the lifetime of the entity, it is illegal to return capital to the shareholdrers in conformance
with the trust fund doctrine.

 However, wasting assets corporations may declare dividends which are in part distribution of
earnings and in part distribution of capital.
  This rule is in conformity with wasting asset doctrine which holds that a wasting asset entity can
declare dividends not only to the extent of the retained earnings balance but also to the extent
of the accumulated depletion balance.

 A wasting asset entity is an entity engaged solely or substantially in the exploitation of natural
resources.

21. Dividends as expense

 Distribution to holders of an equity instrument shall be debited by the entity directly to equity
(PAS 32, paragraph 35).

 In other words, dividends out of earnings are charged to retained earnings.

 PAS Paragraph 36 provides that distribution to holders of an equity instrument classified as

financial liability are recognized in the same as interest expense on a bond.

 Paragraph 40 further provides that dividends classified as an expense emay be presented in the
income statement either with interest on other liabilities or as a separate line item.

 The best example of an equity instrument classified as financial liability is a redeemable preference
share.

 A redeemable preference share is a preference share with mandatory redemption date or preference
share that must be redeemed at the option of the holder.

B. Application Exercises

Exercises pertaining to this Learning Resource are provided here with the necessary solutions. Analysis
was made using appropriate accounting principles as discussed in Activity 1.

Exercise 1

On December 21, 2021, NBC Company showed the following shareholders’ equity:

Share capital, P100 par, 100,000 share authorized, 50,000 shares

issued 5,000,000
Share premium 1,000,000
Retained earnings 2,000,000
Treasury shares, 5,000 at cost 600,000

On December 31, 2021, NBC Company declared a cash dividend of P30 per share to shareholders of record
on January 15, 2022 and payable on January 31, 2022.

Required:
Prepare journal entry on December 31, 2021, January 15, 2022 and January 31, 2022.

Solution to Exercise 1

12.31.21 Retained earnings (45,000 sh x P30) 1,350,000

Dividends payable 1,350,000
Dividends declaration.

1.15.22 No entry

1.31.22 Dividends payable 1,350,000

Payment of dividends to shareholders of 1,350,000
record on January 15, 2022.
 Exercise 2

Promo Company owned 10,000 shares of equity securities of STAR Company with carrying amount of P90
per share. On October 31, 2021, Candel Company declared these shares as property dividend to be paid on
March 31, 2022.

The qouted price for XYZ share is P130 on October 31, 2021, P150 on December 31, 2021 and P110 on
March 31, 2022.

Required: Prepare journal entries in connection with the property dividend.

Solution to Exercise 2

2021
Oct. 31 - Retained earnings (10,000 sh x P130) 1,300,000
Dividends payable 1,300,000

Dec. 31 - Retained earnings 200,000

Dividends payable 200,000

Fair value – 12.31.21 (10,000 sh x P150) 1,500,000

Fair value – 10.31.21 (10,000 sh x P130) 1,300,000
Increase in dividends payable 200,000

No adjustment of the carrying amount of P900,000 (10,000 sh x P90) because this

is lower than the fair value of 1,500,000 on December 31, 2021.

2022
March 31 Dividends payable 400,000
Retained earnings 400,000

Fair value – 3.31.22 (10,000 sh x P110) 1,100,000

Fair value – 12.31.21 1,500,000
Decrease in dividends payable (400,000)

Dividends of payable 1,100,000

Investment in equity securities 900,000
Gain on distribution of property
Dividend 200,000
Settlement of dividends payable.

Dividends payable – 3.31.22 (1,300,000+200,000-400,000) 1,100,000

Carrying amount of investment (10,000 sh x P90) 900,000
Gain on distribution of property dividend 200,000

Exercise 3

On January 1, 2021, HR Company reported the following shareholders’ equity:

Share capital 1,500,000
Share premium 3,000,000
Retained earnings 5,000,000

The entity had 400,000 authorized shares of P5 par value, of which 300,000 shares were issued and
outstanding. On March 1, 2021, the entity acquired 50,000 shares, for P10 per share to be held as treasury.
The shares were originally issued at P8 per share. The entity used the cost method to account for treasury
shares.

On July 1, 2021, the entity declared a property divided of inventory payable on March 1, 2022.

The inventory had a P1,200,000 carrying amount and a fair value of P1,500,000 on July 1, 2021, P1,800,000
on December 31, 2021 and P2,000,000 on March 1, 2022.

The net income for 2020 was P3,000,000.

Required:
Prepare journal entries for 2021 and 2022 in connection with treasury shares, property dividend and net
income.
 Solution to Exercise 3

2021
March 1 - Treasury shares 500,000
Cash (50,000 sh x P10) 500,000

July 1 - Retained earnings 1,500,000

Dividend payable 1,500,000

Dec. 31 - Retained earnings 300,000

Dividend payable 300,000

Fair value – 12.31.21 1,800,000

Fair value – 7.01.21 1,500,000
Increase in dividends payable 300,000
2022
March 1 - Retained earnings 200,000
Dividend payable 200,000

Fair value – 3.01.22 2,000,000

Fair value – 12.31.21 1,800,000
Increase in dividends payable 200,000

Dividend payable 2,000,000

Inventory 1,200,000
Gain on distribution of property dividend 800,000

Dividend payable, 3.01.22 2,000,000

Carrying amount 1,200,000
Gain on distribution of property dividend 800,000

Exercise 4

APOL Company showed the following balances at year-end:

Wasting asset 8,000,000
Accumulated depletion 1,000,000
Share capital, P100 par 5,000,000
Capital Liquidated 500,000
Retained earnings 1,200,000
The Board of Directors declared a dividend of P30 per share at year-end.

Required:
Prepare journal entry for the declaration of the dividend and the subsequent payment.

Solution to Exercise 4
1. Retained earnings 1,200,000
Capital liquidated 300,000
Dividend payable (50,000 sh x P30) 1,500,000
Declaration of dividends.

2. Dividend payable 1,500,000

Cash 1,500,000
Payment of dividends.

Exercise 5

VIGOR Company showed the following data:

Share capital, par value P100, 50,000 share issued 5,000,000
Share premium 200,000
Retained earnings 2,000,000
Market value of share on declaration date 150
Market value of share on distribution date 170

Required:
For earch of the following, prepare journal entries on the date of declaration and date of payment:

1. A 20% share dividend is declared.

2. A 10% share dividend is declared.
 Solution to Exercise 5

1. 20% - based on par value (50,000 sh x 20%) = 10,000 shares

Retained earnings (10,000 sh x P100) 1,000,000
Share dividend payable 1,000,000
Declaration of dividend.

Share dividend payable 1,000,000

Share capital 1,000,000
Payment of dividend.

2. 10% - based on market value (50,000 sh x 10%) = 5,000 shares

Retained earnings (5,000 sh x P150) 750,000
Share dividend payable (5,000 sh x P100) 500,000
Share premium 250,000
Declaration of dividend.

Share dividend payable 500,000

Share capital 500,000
Payment of dividend.

Exercise 6

VALOR Company provided the following transactions:

2021
Sept. 15 Declared a 20% share dividend on 100,000 shares par value P10.

The share were originally sold at 15.

Oct. 15 Distributed the share dividend declared on September 15 which included fractional
warrants for 2,000 shares.

Dec. 1 One thousand five hundred share were issued for fractional warrants.

The remaining warrants were expired.

2022
Sept. 15 Declared scrip dividend of P2 per share payable on November 15, 2021 with interest
at 12%

Nov. 15 Paid and script dividend

Dec. 1 Declared dividend of 1 share of Sharp Company on every share of National Company
owned.

Sharp Company shares are carried at a cost of P3 per share and the market value is P4
per share.

Dec. 31 Distributed the Sharp Company shares to shareholders. The market value of Sharp
Company share is P6.

Required:
Prepare journal entries to record the transactions

Solution to Exercise 6

2021
9.15 Retained earnings (100,000 sh x P10 x 20%) 200,000
Share dividend payable 200,000

10.15 Share dividend payable 200,000

Share capital (18,000 sh x P10) 180,000
Fractional warrants outstanding (2,000 sh x P10) 20,000
 12.01 Fractional warrants outstanding (2,000 sh x P10) 20,000
Share capital (1,500 sh x P10) 15,000
Share premium 5,000

2022
9.15 Retained earnings (119,500 sh x P2) 239,000
Scrip dividend payable 239,000

Scrip dividend payable 239,000

Interest expense (239,000 x 12% x 2/12) 4,780
Cash 243,780

12.01 Retained earnings 478,000

Dividend payable 478,000
(119,500 sh x P4)

12.31 Retained earnings 239,000

Dividend payable 239,000
Increase of P2 (P4-P2) = (119,500 sh x P2)

12.31 Dividend payable 717,000

Investment in Sharp Company (119,500 sh x P3) 358,500
Gain on distribution of property dividend 358,500

C. Evaluation Exercises
General Instructions: You are required to provide solutions/answers to the following exercises. Supporting
computations which are presented in good form shall be part of all solutions.

A. Theoretical Exercises (Group Task)

Choose the correct answer by writing the corresponding letter-answer and a convincing justification that it
is indeed the correct answer via applicable appropriate accounting principles discussed in Activity 1.

1. Retained earnings represent

a. Earned capital b. cash c. Assets d. Net assets

2. Retained earnings represent

a. Undistributed net income
b. Undistributed net assets
c. Extra contributed capital
d. Undistributed cash

3. The total retained earnings balance typically is not affected by

a. Net income c. Dividends paid
b. A prior period error d. Restrictions

4. When a property dividend is declared, the dividend payable should be measured based on the fair value
of property on
a. Record date
b. Distribution date
c. Declaration date, reporting date and distribution date
d. Reporting date

5. The declaration and issuance of a share dividend on ordinary shares

a. Has no effect on assets, liabilities and total shareholders’ equity
b. Decrease total shareholders’ equity and increases ordinary shares
c. Decreases assets and total shareholders’ equity
d. Does not change retained earnings or ordinary shares

6. An entity declared a cash dividend on a certain date payable on another date. Retained earnings would

a. Increase on the date of declaration

b. Not be affected on the date of declaration
c. Not be affected on the date of payment
d. Decrease on the date of payment
7. The actual total amount of a cash dividend to be paid is determined on the date of
a. Record c. Payment
b. Declaration d. Declaration or record, whichever is earlier

8. A dividend which is a return to shareholders of a portion of their original investment is

a. Liquidating dividend c. Liability dividend
b. Patronage dividend d. Participating dividend

9. Total shareholders’ equity is not affected by the

a. Issuance of a share dividend
b. Conversion of bonds payable into share capital
c. Sale of treasury shares at more than cost
d. Declaration of a cash dividend

10. How would the declaration and subsequent issuance of a 10% share dividend affect share capital and
share premium, respectively, when the fair value of the share exceeds par value?
a. No effect and No effect c. Increase and No effect
b. No effect and Increase d. Increase and Increase

B. Practical Exercises - Group Task

Solve the following problems by group with supporting computations presented in good form.

1. On December 31, 2021, WEISS Company showed the following shareholders’ equity:

Share capital, P100 par, 100,000 shares authorized, 50,000 shares

Issued 5,000,000
Share premium 1,000,000
Retained earnings 2,000,000
Treasury shares, 5,000 at cost 600,000

On December 31, 2021, Zebra Company declared a cash dividend of Ᵽ30 per share to shareholders of
record on January 15, 2022 and payable on January 31, 2022.

Required:
Prepare journal entry on December 31, 2021, January 15, 2022 and January 31, 2022.

2. BAC Company owned 10,000 shares of equity securities of CAB Company with carrying amount of
Ᵽ90 per share. On October 31, 2021, BAC Company declared these shares as property divided to be
paid on March 31, 2022.

The quoted price for CAB share is Ᵽ130 on October 31, 2021, Ᵽ150 on December 31, 2021 and Ᵽ110
on March 31, 2022.

Required:
Prepare a journal entries in connection with the property dividend.

3. On January 1, 2021 JESSA Company reported the following shareholders’ equity:

Share capital 1,500,000
Share premium 3,000,000
Retained earnings 5,000,000

The entity had 400,000 authorized shares of Ᵽ5 par value, of which 300,000 shares were issued and
outstanding. On March 1, 2021, the entity acquired 50,000 shares for Ᵽ10 per share to be held as
treasury.

The shares were originally issued at Ᵽ8 per share. The entity used the cost method to account for the
treasury shares. On July 1, 2021, the entity declared a property dividend of inventory payable on March
1, 2022. The inventory had a Ᵽ1,200,000 carrying amount and fair value of Ᵽ1,500,000 on July 1,
2021, Ᵽ1,800,000 on December 31,2021 and Ᵽ2,000,000 on March 1, 2022.

The net income for 2021 was 3,000,000.

Required:
Prepare journal entries for 2020 and 2021 in connection with treasury shares, property dividend and
net income.
4. On October 1, 2021, GRACIA Company declared a property dividend of machinery payable on April
1, 2022.

The carrying amount of the machinery is Ᵽ4,000,000 on October 1, 2021.

The machinery had the following fair value:

October 1, 2021 3,800,000
December 31, 2021 3,700,000
April 1, 2022 3,500,000

Required:
Prepare journal entries for 2021 and 2022 in connection with the property dividend.

5. NORKIS Company showed the following balances:

Share capital authorized Ᵽ100 par 50,000 shares 5,000,000
Share capital unissued, 20,000 shares 2,000,000
Subscribed share capital, 10,000 shares 1,000,000
Treasury shares (5,000 at cost) 600,000
Share premium 500,000
Retained earnings 1,500,000

Market value share:

On declaration date 140
On issuance date 150

Required:
Prepare journal entries assuming the Board of Directors declared:
1. A share dividend from unissued share capital of one share for each ten shares outstanding.
2. A share dividend from the treasury shares of one share for each ten shares outstanding. The cost of
the treasury shares is capitalized.
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