Corporations:

Retained Earnings and the

Income Statement

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 Retained Earnings
• All net income minus net losses minus
dividends
• Negative balance in Retained Earnings -
deficit
• Not a fund of cash

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 Objective 1

Account for stock dividends

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 Stock Dividend
• Proportional distribution of corporation’s
own stock to shareholders
• Does not change total stockholders’ equity
• Transfer of retained earnings to
contributed capital – no assets are
distributed

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 Entries for Stock Dividend
Small Large
• Distribution is < 20- • Distribution is > 25% of
25% of previously previously outstanding
outstanding shares shares
• Debit retained • Debit retained earnings
earnings for market for par or stated value
value of shares to be of shares
distributed

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 E14-13
How many shares of stock are distributed?
50,000 × 10% = 5,000 shares

How much will be debited to retained earnings?

5,000 shares x $14 = $70,000

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 E14-13
GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT

Apr 30 Retained Earnings 70,000

Common Stock 5,000
Paid in Capital in Excess of
Par, Common 65,000

USE MARKET
USE PAR VALUE
5,000
Common shares
stock x $14
= 5,000 shares x $1

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 E14-13
The number of shares
Retained earnings decreased
issued increased.
Stockholders’ Equity:
Paid in Capital:
Common stock, $1 par, 100,000 shares
authorized, 55,000 shares
Total stockholders’ issued
equity is $55,000
Paid in capital the
in excess
same of par 265,000
Total paid in capital $320,000
Retained earnings ($120,000-70,000) 50,000
Total stockholders’ equity $370,000

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 Stock Splits
• Increases the number of shares
authorized, issued and outstanding
• Decreased par value per share
• Balances in the accounts are unchanged
• Record in a memorandum entry

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 E14-15
GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT

Jun 30 Called in the outstanding $1

par common stock and
distributed 2 shares of $0.50
par common stock for each old.
There are now 100,000 shares
outstanding.

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 E14-3Shares authorized and
Par value is cutissued
in half are double

Stockholders’ Equity:
Paid in Capital:
Common stock, $0.50 par, 400,000 shares
authorized, 100,000 shares issued $50,000
Paid in capital in excess of par 100,000
Total paid in capital $150,000
Retained earnings 200,000
Total stockholders’ equity $350,000
None of the amounts in the
accounts have changed

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 Objective 2

Distinguish stock splits from stock

dividends

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 Comparison: Stock
Dividends & Stock Splits
Stock Dividend: Stock Split:
• Shifts amounts from • Account balances do not
retained earnings to paid- change
in capital
• Par value per share • Par value decreases
remains unchanged
• Number of shares of stock
• Number of shares issued authorized, issued, and
increases outstanding increase
• Total stockholders’ equity
• Total stockholders’ equity does not change
does not change

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 Objective 3

Account for treasury stock

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 Treasury Stock
• Shares that a company has issued and
later reacquired
• Purchasing treasury stock decreases
assets and stockholders’ equity
• Contra equity account
• Record at cost
• Report after retained earnings on balance
sheet

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 E14-17
GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT

Feb 4 Cash 200,000

Common Stock 20,000
Paid in Capital in Excess of
Par, Common 180,000

Apr 22 Treasury Stock 14,000

Cash 14,000

Contra Equity Account

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 E14-17
GENERAL JOURNAL
DATE DESCRIPTION REF DEBIT CREDIT

Aug 22 Cash 12,000

Treasury Stock 8,400
Paid in Capital from
Treasury Stock Transactions 3,600

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 E14-17
Paid in Capital Paid in Capital
In Excess of Par, from Treasury
Common Stock Common Stock Transactions
20,000 180,000 3,600

Retained Earnings Treasury Stock

100,000* 14,000 8,400

5,600

*Assumed
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 Austin Driving School, Inc.
Partial Balance Sheet
December 31, 2008
Stockholders’ Equity
Paid in Capital:
Common Stock $20,000
Paid in Capital in Excess of Par, Common 180,000
Paid in Capital from Treasury Stock
Transactions 3,600
Total Paid in Capital $203,600
Retained Earnings 100,000
Subtotal $303,600
Less Treasury Stock (400 shares at cost) 5,600
Total Stockholders’ Equity $298,000
*Assumed
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 Shares Issued & Outstanding
• Issued shares – number of shares sold
• Outstanding shares – number of shares in
the hands of stockholders
• Treasury stock decreases the number of
shares outstanding
• Treasury stock does not receive dividends
In the previous example, then, the number of shares
issued are 20,000. The number of shares outstanding
are 19,600 (20,000 – 400 shares in treasury)
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 Retirement of Stock
• Decreases outstanding stock
• Retired shares cannot be reissued
• Remove stock from books
– Debit stock accounts
– Credit cash

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 Objective 4

Report restrictions on retained

earnings

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 Restrictions on Retained
Earnings
• Reported in notes to financial statements
• Restricts amount of retained earnings
available for dividends
• Appropriations are restrictions on retained
earnings recorded by formal journal
entries

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 E14-19 a
Stockholders’ equity:
Common stock, no par $50,000
Retained earnings—Note X 250,000
Total stockholders’ equity $300,000

Note X— Long-term debt (or Restriction of

retained earnings). The company’s long-term
debt agreement restricts retained earnings in
the amount of $200,000.

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 E14-19 b
Stockholders’ equity:
Total paid-in capital $50,000
Retained earnings:
Appropriated for debt agreement $100,000
Unappropriated 150,000
Total retained earnings 250,000
Total stockholders’ equity $300,000

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 Objective 5

Analyze a corporate income

statement

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 Corporate Income Statement
Continuing Operations Normal operating
revenues and expenses,
including income tax
expense
Items that are material in
amount, but are not
Special Items typical of regular
operations
Amount of net income for
each share of outstanding
Earnings Per Share common stock

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 Income from Continuing
Operations
• Measures profitability of the ongoing
operations
• Useful for making projections about future
earnings

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 Special Items
• Reported after income from continuing
operations
– Discontinued operations
– Extraordinary gains and losses

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 Discontinued Operations
• Segment of a business that has been sold
• Two parts
– Income or loss from operations of business
from beginning of year to date of disposal
– Gain or loss on disposal of the assets of the
segment
– Reported net of the income tax effect

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 Extraordinary Items
• Both unusual and infrequent
– Unusual in nature – abnormal and only
incidentally related to customary activities
– Infrequent in occurrence – not reasonably
expected to happen in the foreseeable future
• Reported net of income tax effect

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 E14-20
Conner Photographic Supplies, Inc.
Income Statement
Year Ended December 31, 2008
Sales revenue $430,000
Cost of goods sold (240,000)
Gross profit $190,000
Operating expenses (120,000)
Income from continuing operations $70,000
Loss on discontinued operations $(50,000)
Income tax savings 20,000 (30,000)
Income before extraordinary items $40,000
Extraordinary loss $(15,000)
Income tax savings 6,000 (9,000)
Net income $31,000
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 Earnings Per Share

Net income - Preferred dividends

Average number of common shares outstanding

Report separate EPS figures for each line on

income statement starting with income from
continuing operations though to net income
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 Earnings Per Share
and Preferred Stock
Corporations with complex capital structures
present two sets of EPS amounts
• Basic EPS
• Diluted EPS

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 E14-21
Net income - Preferred dividends
Average number of common shares outstanding

$108,000 – (1,000 x 6% x $50)

(52,000 shares – 2,000 shares)
= $105,000 / 50,000 shares
= $2.10

Remember: Treasury stock is

not considered outstanding
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 E14-22
Preferred dividends:10,000 × $10 × .05 = $5,000
Earnings per share:
Income from continuing operations
[($110,000 – $5,000) / 50,000] $2.10
Loss on discontinued operations ($8,000 / 50,000) (.16)
Income before extraordinary items
[($102,000 – $5,000) / 50,000] $1.94
Extraordinary gain ($20,000 / 50,000) .40
Net income [($122,000 – $5,000) / 50,000] $2.34

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Statement of Retained Earnings
• Reports how retained earnings changed
over the accounting period
• Beginning balance + net income –
dividends = Ending balance

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 Comprehensive Income
• Change in total stockholders’ equity from
all sources other than from its owners
– Net income
– Unrealized gains/losses on certain
investments
– Foreign currency translation adjustments

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 Prior Period Adjustments
• Corrections to beginning balance of Retained
Earnings for errors of an earlier period
• Correcting entry includes
– Debit or credit to Retained Earnings for error amount
– Debit or credit to asset or liability account that was
misstated
• Reported on Statement of Retained Earnings

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 E14-24
Sarah Lou Bakery, Inc.
Statement of Retained Earnings
Year Ended December 31, 2003
Millions
Retained earnings, December 31, 2002,
as originally reported $39,000
Prior period adjustment (5,000)
Retained earnings, December 31, 2002,
as adjusted 34,000
Net income for 2003 70,000
Subtotal 104,000
Dividends for 2003 (24,000)
Retained earnings, December 31, 2003 $80,000

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