CHAPTER 8 RETAINED EARNINGS 1.

Retained earnings reflect the cumulative earnings of the corporation that have been retained for use in the business rather than distributed to its owners or stockholders as dividends. 2. Retained earnings are ; - not cash - in the shareholders' equity section of the balance sheet. - increased by net income and decreased by dividends and by a net loss. 3. If the Retained Earnings account has a negative balance because cumulative losses and dividends have exceeded cumulative net income, this account is referred to as an accumulated deficit. CASH DIVIDENDS 1. Corporations must meet several requirements to pay a cash dividend; i. ii. iii. dividends must be declared by the board of directors before they can be legally paid must have sufficient cash and retained earning to pay the dividend. corporations are not legally required to pay dividends, but once declared a legal liability is created.

* Note that dividends are not an expense and do not appear on the income statement. Dividends are a distribution of earnings of the corporation to its stockholders and are treated as a direct reduction of retained earnings. STOCK DIVIDENDS AND STOCK SPLITS 1. Stock dividend is the distribution of additional shares of stock to existing stockholders in proportion to the number of shares each currently owns. It requires journal entries. Move account from retained earning (debit) to paid-in capital (credit). 2. No change in par value of stock or in total stockholders equity. 3. Stockholders retain percentage ownership in the company (preemptive right) 4. Reasons for stock dividends: - Preserve cash - Decrease market price of stock

- Reduce retained earnings. 5. A stock split involves issuing additional shares to existing stockholders and, if the stock has a par value, reducing the par value proportionately. 6. No accounting entry is required for a stock split. However, the common stock caption of owners equity indicates the drop in par value per share and the proportionate increase in the number of shares authorized, issued, and outstanding. If the corporation has used nopar-value stock, only the number of shares changes. 7. Total ownership is unchanged and total par value is unaffected.

Notes ; A share has a certain declared face value, commonly known as the par value of a share. The par value is the de minimis (minimum) amount of money that a business may issue and sell shares for in many jurisdictions and it is the value represented as capital in the accounting of the business. In other jurisdictions, however, shares may not have an associated par value at all. Such stock is often called non-par stock. Shares represent a fraction of ownership in a business. A business may declare different types (classes) of shares, each having distinctive ownership rules, privileges, or share values.

CHAPTER 9

STATEMENT OF CASH FLOWS 1. Provides relevant information about the cash receipts and cash payments of an enterprise during a period. The statement shows why cash and cash equivalents changed during the period by reporting net cash provided or used by :i. ii. iii. Operating activities Investing Activities Financing Activities CASH INFLOWS Operating Investing Financing

Cash received from Sale of operational Issuance of stock revenues assets Issuance of bonds Sale of investments and notes Collections of loans

CASH OUTFLOWS Cash paid expenses for Purchase of Payment operational assets dividends Purchase investments Loans to others of

of Repurchase of stock Repayment of debt

Contents and Format of the Statement 1. There are 2 approaches to present the operating activities section of the statement of cash flows; i. Direct method presentation listing each major class of cash receipt transactions and cash disbursements transactions for each of the three activity areas. Indirect method presentation explains cash flows from operating activities by explaining the change in each noncash operating account in the balance sheet. Shows net income as the first source of operating cash. Significant Noncash income statements are total depreciation and amortization expense.

ii.

9-14 1-14

Cash Flows from Operating Activities

Direct Presentation
Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Cash Flows from Operating Activities Cash Flows from Investing Activities Proceeds from sale of Equipment Cash Flows from Financing Activities Proceeds from sale of Stock Principal paid on Bonds Principal paid on Notes Net Cash Flows for the Period Add: Beginning Cash Balance Ending Cash Balance
McGraw-Hill/Irwin

Supplemental Reconciliation
$ 175,000 120,000 27,630 27,370

43,000

Net Income $ 15,020 Add (Deduct) items not affecting cash: Depreciation expense 5,000 Increase in accounts payable 4,600 Minority interest in subsidiaries 25,000 Gain on sale of land (17,250) Increase in accounts receivable (3,000) Increase in inventory (2,000) Net Cash Flow from Operations $ 27,370

50,000 (100,000) (10,000)

(60,000) 10,370 21,000 $ 31,370

Note that net cash flow from operations and cash flows from operating activities reconcile.
2008 The McGraw-Hill Companies, Inc., All Rights Reserved.
9-15 1-15

Statement of Cash Flows

Indirect Presentation
Net Income Add (Deduct) items not affecting cash: Depreciation expense Increase in accounts payable Minority interest in subsidiaries Gain on sale of land Increase in accounts receivable Increase in inventory Net Cash Flow from Operations Cash Flows from Investing Activities Proceeds from sale of Equipment Cash Flows from Financing Activities Proceeds from sale of Stock $50,000 Principal paid on Bonds (100,000) Principal paid on Notes (10,000) Net Cash Flows for the Period Add: Beginning Cash Balance Ending Cash Balance
McGraw-Hill/Irwin

$ 15,020 5,000 4,600 25,000 (17,250) (3,000) (2,000) 27,370 43,000

About 98% of major corporations use the indirect method of presentation!

(60,000) 10,370 21,000 31,370

2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

*Note that the difference between 2 methods is only the presentation of cash flow from operating ctivities.

Interpreting the Statement of Cash flows

1. It involves observing the relationship between the 3 broad categories of cash flows (operating, investing & financing activities) and the change in the cash balance for the year. 2. Cash provided from operating activities should be equal to or greater than cash used for investing. A business entity should have positive cash flows from operational activities. If operating activities do not generate cash, the entity must look to outside parties for funds to meet its day-to-day activities.

CHAPTER 10 CORPORATE GOVERNANCE, EXPLANATORY NOTES, AND OTHER DISCLOSURES Corporate Governance (CG) The framework of rules and practices by which a board of directors ensures accountability, fairness, and transparency in a company's relationship with its all stakeholders (financiers, customers, management, employees, government, and the community). CG addresses issues such as; Business ethics Social responsibility Equitable treatment of shareholders Disclosures and transparency (full and fair disclosure) Board of directors responsibility Despite the increased attention paid to governance and related matters in recent years, a variety of financial problems continue to exist today.

Financial Reporting Misstatements 1. 2. 3. 4. 5. 6. 7. Reporting revenue too soon or that is of questionable quality Recording bogus revenue Boosting income with 0ne-time gains Shifting current expenses to a later or earlier period Failing to record or improperly reducing liabilities Shifting current revenue to a later period Shifting future expenses to the current period as a special charge

General Organization of Explanatory Notes Explanatory notes are an integral part of the financial statements because they contain important disclosures that are not contained in the financial statements themselves. For financial statements to be relevant, reliable and understandable, users must read and interpret explanatory notes to make informed decisions and judgments. They are generally presented in the same sequence as the financial statements.