Retained Earnings,

Treasury Stock, and

the Income Statement
Chapter 14
Retained Earnings
 Accumulates income that has been retained in
the business (that is, not paid out in dividends to
stockholders) over life of business.
 All net income minus net losses minus
dividends
 Negative balance in Retained Earnings - deficit
 Not a fund of cash
Objective 1
Account for stock dividends.
Stock Dividend
 Proportional distribution of corporation’s
own stock to shareholders (10%)
 Does not change total stockholders’ equity
 Transfer of retained earnings to
contributed capital
Entries for Stock Dividend
Small Large
 Distribution is < 25%  Distribution is > 25% of
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
Small Stock Dividend Example
San Diego Company, with 300,000 shares
of $2 par value common stock
outstanding, declares a 15% stock
dividend when the shares are trading at
$20.
Small Stock Dividend Example
How much stock do the shareholders
receive?
 300,000 × 15% = 45,000 shares
 Small Stock Dividend Example
General Journal
Date Accounts and Explanations PR Debit Credit
Dec 31 Retained Earnings 900,000
Common stock 90,000
Paid in capital in excess of par,
common 810,000
15% stock dividend distributed

USE MARKET
USE PARVALUE
Common45,000 shares
stock = 45,000x shares
$20 x $2
Large Stock Dividend Example
San Diego Company, with 300,000 shares
of $2 par value common stock
outstanding, declares a 40% stock
dividend when the shares are trading at
$20.
Large Stock Dividend Example
 How much stock do the shareholders
receive?
 300,000 × 40% = 120,000 shares
 Large Stock Dividend Example

General Journal
Date Accounts and Explanations PR Debit Credit
Dec 31 Retained Earnings 240,000
Common stock 240,000
40% stock dividend distributed

USE PAR
120,000 shares x $2
Stock Split Example
San Diego Company had 500,000 shares of $10
par common stock authorized and 100,000
issued. A 5-for-1 stock split was declared.
 After the split, how many shares are
 Authorized? 500,000 x 5 = 2,500,000
 Issued? 100,000 x 5 = 500,000
 What is the par value per share? $10 ÷ 5 = $2

Why do companies perform Stock Splits???

 Stock split
 No formal entry is made, but a memo entry
is prepared in the journal.
General Journal
Date Accounts and Explanations PR Debit Credit
Dec 31 Memo: Called in the outstanding $10
par common stock and distributed 5
shares of $2 par ($10/5) common
stock for each old share. Now
500,000 shares are outstanding.
Objective 2
Distinguish stock splits from stock dividends.
Similarities Between Stock
Splits and Stock Dividends
 Both increase number of shares of stock
owned per stockholder.
 Neither type of income creates taxable
income for investor.
Differences Between Stock
Splits and Stock Dividends
Stock Dividend: Stock Split:
 shifts amounts from  affects no account
retained earnings to balance.
paid-in capital.  Changes par value
 par value per share  Increases number of
remains unchanged. shares of stock
authorized, issued,
and outstanding.
Objective 3
Account for treasury stock.
Treasury Stock...
 Shares that a company has issued and
later reacquired
 Purchasing treasury stock decreases
assets and stockholders’ equity
 Purchasing Treasury Stock
On May, 8, 2002, Whitt, Inc. purchased
2,000 of its own shares of stock in the
open market for $8,000.
General Journal
Date Accounts and Explanations PR Debit Credit
May 8 Treasury stock, common 8,000
Cash 8,000

Keep track of the cost per share: $8,000 / 2,000 = $4

 Selling Treasury Stock at Cost
On June 30, 2002, Whitt sold 100 shares of
its treasury stock for $4 per share.
General Journal
Date Accounts and Explanations PR Debit Credit
Jun 30 Cash 400
Treasury stock, common 400
 Selling Above Cost
On July 19, Whitt sold an additional 500
shares of its treasury stock for $8 per
share.
General Journal
Date Accounts and Explanations PR Debit Credit
Jul 19 Cash 4,000
Treasury stock, common 2,000
Paid in capital-treasury stock 2,000
500 X $4 original cost
 Selling Below Cost
On August 27, Whitt sold an additional 400
shares of its treasury stock for $1.50 per
share.
General Journal
Date Accounts and Explanations PR Debit Credit
Aug 27 Cash 600
Paid in capital – treasury stock 1,000
Treasury stock, common 1,600

400 X $4 original cost

Retirement of Stock...
 Decreases outstanding stock
 Retired shares cannot be reissued
 There is no gain or loss on retirement
Objective 4
Report restrictions on retained earnings.
Restrictions on Retained
Earnings
 Reported in notes to financial statements
 Appropriations are restrictions on retained
earnings that are recorded by formal
journal entries
Objective 5
Analyze a complex income statement.
Reporting Income Information
 Should help to predict how the company
will perform in the future
 Items that are material in amount, but are
not typical of regular operations, reported
separately from continuing operations
 See page 555
Income from continuing operations

 Measures profitability of the ongoing

operations
 Useful for making projections about future
earnings
Special Items
 Reported after income from continuing
operations
 Discontinued operations
 Extraordinary gains and losses
 Cumulative effect of an accounting change –
NO LONGER REPORTED ON THE INCOME
STATEMENT!!!
 Discontinued Segment
 Segments of a business that have been sold
 Two parts reported in this section
 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
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 their tax effect.
 Accounting rules specify extraordinary items.
Extraordinary Items
 Extraordinary items include expropriations.
 May include losses due to natural disasters.
 hurricane
 flood
 fire
Changes in Accounting
Methods
 Adoption of a newly required accounting
standard
 Changing accounting methods
 Per FASB, it is now recorded as a “Prior
Period Adjustment,” adjusting the retained
earnings balance.
Earnings Per Share

Net income - Preferred dividends

Weighted-average common shares outstanding
Earnings Per Share Example
 On January 1, San Diego Company had
100,000 common shares outstanding.
 On April 1, the company purchased 15,000
treasury shares.
 On September 1, they issued 50,000 new
shares.
 Income for the year was $135,000.
 What are the earnings per share?
Earnings Per Share Example

No. of Shares Fraction Weighted

Outstanding of Year Average
100,000 × 3/12 = 25,000
85,000 × 5/12 = 35,417
135,000 × 4/12 = 45,000
Total 105,417

EPS = $135,000 ÷ 105,417 = $1.28

Earnings Per Share and
Preferred Stock
 Subtract preferred dividends from income
subtotals (income from continuing operations,
income before extraordinary items, and net
income) in computation of EPS
 Preferred dividends are not subtracted from
income or loss from discontinued operations,
or from extraordinary gains or losses
Earnings Per Share
and Preferred Stock
Corporations with complex capital structures
present two sets of EPS amounts.
 EPS based on outstanding common
shares (basic EPS)
 EPS based on outstanding common
shares plus the number of additional
common shares that would arise from
conversion of the preferred stock
Prior Period Adjustments...
Corrections to beginning balance of
Retained Earnings for errors of an earlier
period.
 Correcting entry includes a debit or credit
to Retained Earnings for error amount.
 Also includes debit or credit to the asset or
liability account that was misstated.
Statement of Retained Earnings
 See page 559
Objective 6
Prepare a Statement of Stockholders’
Equity.
Statement of
Stockholders’ Equity
 More comprehensive than statement of
retained earnings
 Reports changes in all categories of equity
Statement of Stockholders’
Equity
 See page 560