Chapter 21

Corporate Earnings, Taxes, and Distributions

McGraw-Hill/Irwin

Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objective 1
Compute and record corporate income tax.
Corporations pay taxes based on their taxable income.

LO1

Taxable income Less income taxes = Net income

Surf Outlet expects taxable income of $210,000 for 2010. Its estimated tax liability is computed as follows:
Taxable Income Level Amount 1st $ 50,000 2nd 25,000 3rd 25,000 4th 110,000 Total $ 210,000

Tax Rate 15% 25% 34% 39%

Tax Liability $ 7,500 6,250 8,500 42,900 65,150

The entry to record the first quarterly payment on April 15 is:

Apr. 15 Income Tax Expense Cash (1/4 $65,150)

16,287.50 16,287.50

Surf Outlets quarterly tax payments are $16,287.50 ($65,150/4 quarters). We record the entry for the first quarterly income tax payment on April 15 by debiting Income Tax Expense for $16,287.50 and crediting Cash for the same amount. 21-2

LO1

Adjusting Tax Liability to Amount Owed Based on Actual Taxable Income

Overpayment of Taxes
Tax payments made in 2010 Tax liability in 2010 Tax refund $ $ 65,150.00 59,016.47 6,133.53

The entry to record the tax refund receivable on December 31 is:

Dec. 31 Income Tax Refund Receivable Income Tax Expense

6,133.53 6,133.53

Underpayment of Taxes

Tax payments made in 2010 Tax liability in 2010 Additional taxes owed

$ $

65,150.00 66,586.37 (1,436.37)

The entry to record the additional tax payable on December 31 is

Dec. 31 Income Tax Expense Income Tax Payable

1,436.37 1,436.37
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Learning Objective 2
Record transactions involving cash dividends.

LO2

On January 19, a $1 per share cash dividend is declared on Dana, Inc.s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19.
Date of Declaration

Record liability for dividend.

Jan. 19 Retained Earnings 10,000 Common Dividend Payable

Declared $1 per share cash dividend

10,000

Date of Record

No entry required.

No entry required on February 19.

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LO2

Entries for Cash Dividends

On January 19, a $1 per share cash dividend is declared on Dana, Inc.s 10,000 common shares outstanding. The dividend will be paid on March 19 to stockholders of record on February 19.

Mar. 19

Common Dividend Payable Cash

10,000 10,000

Paid $1 per share cash dividend

Date of Payment

Record payment of cash to stockholders.

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LO3

Learning Objective 3
Account for stock dividends and stock splits.

The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return.

Why a stock dividend?

100 shares

HotAir, Inc. Common Stock

$1 par

Can be used to keep the market price of the stock affordable. Can provide evidence of managements confidence that the company is doing well.
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LO3

Recording a Small Stock Dividend

On December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, 2011. Lets make the December 31 entry.

Dec. 31 Retained Earnings 20,000 Common Stock Dividend Distributable Paid-In Capital in Excess of Par Value
Declared a 2,000 share (2%) stock dividend

2,000 18,000

On December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling for $10 per share. The stock will be distributed to stockholders on January 20, 2011. Now lets make the January 20 entry.

Jan. 20 Common Stock Dividend Distributable Common Stock, $1 Par Value

2,000 2,000

To record issuance of common stock dividend

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LO3

Recording a Large Stock Dividend

On December 31, 2010, Router declared a 40% stock dividend, when its stock was selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share.

Dec. 31 Retained Earnings

20,000 20,000

Common Stock Dividend Distributable

Declared a 20,000 share (40%) stock dividend

A stock split is the distribution of additional shares to stockholders according to their percent ownership. A 2-for-1 stock split replaces 100,000 shares of $20 par value stock with 200,000 shares of $10 par value stock. Market value is reduced from $88 per share to about $44 per share. The split does not affect any balance sheet amounts or any individual stockholders percent ownership. Both the Paid-In Capital and Retained Earnings accounts are unchanged by a split, and no journal entry is made.
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Learning Objective 4
Distribute dividends between common stock and preferred stock.

LO4

Dividend Preference of Preferred Stock

Example: Consider the following Stockholders Equity Section of a Balance Sheet
Preferred stock, 9%, $100 par value; 1,000 shares authorized, issued and outstanding Common stock, $5 par value; 40,000 shares authorized, issued and outstanding Total Paid-In capital 100,000 $ $ 200,000 300,000

See how this dividend is distributed if the preferred stock is cumulative and if it is noncumulative.

If Preferred Stock is Noncumulative: Year 2009: No dividends paid. Year 2010: 1. Pay 2010 preferred dividend. 2. Remainder goes to common.

Preferred Common $ $ $ 9,000 $ 33,000

If Preferred Stock is Cumulative: Preferred Common Year 2009: No dividends paid. $ $ Year 2010: 1. Pay 2009 preferred dividend in arrears. $ 9,000 2. Pay 2010 preferred dividend. 9,000 3. Remainder goes to common. $ 24,000 Totals $ 18,000 $ 24,000

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Learning Objective 5
Record purchases and sales of treasury stock.

LO5

On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000.
May 8 Treasury Stock, Common Cash at $4 per share 8,000 8,000

Purchase 2,000 treasury shares

Selling Treasury Stock at Cost

On June 30, Whitt sold 100 shares of its treasury stock for $4 per share.
June 30 Cash Treasury Stock, Common
Sold 100 shares of treasury

400 400

for $4 per share

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LO5

Selling Treasury Stock Above Cost

On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share.
July 19 Cash 4,000 Treasury Stock, Common Paid-In Capital, Treasury Stock
Shares Per Share Total Sale 500 $ 8.00 $ 4,000 Cost 500 4.00 2,000 Paid-In Capital $ 2,000

2,000 2,000

Sold 500 treasury shares for $8 per share

Selling Treasury Stock Below Cost

Aug. 27 Cash Paid-in Capital, Treasury Stock Treasury stock, Common 600 1,000 1,600

Sold 400 treasury shares for $1.50 per share

Shares Per Share Total Cost 400 $ 4.00 $ 1,600 Sale 400 1.50 600 Difference $ 1,000

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Learning Objective 6
Describe events that can affect retained earnings.

LO6

Retained earnings can have legal or contractual restrictions. In most states, the corporate charters will not allow companies to purchase treasury stock in excess of the balance in retained earnings. Some loan agreements place restrictions on how much dividends can be based on the balance in retained earnings. A corporations directors can voluntarily limit dividends because of a special need for cash such as the purchase of new facilities.
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Learning Objective 7
Prepare a statement of retained earnings. The Statement of Retained Earnings is a summary of the activity that occurred in Retained Earnings during the period

LO7

Reed, Inc. Statement of Retained Earnings For Year Ended December 31, 2010 Retained earnings, 12/31/09 Plus: net income Less: dividends declared Retained earnings, 12/31/10 $ 875,000 155,600 (80,000) $ 950,600
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Learning Objective 8
Prepare a statement of stockholders equity. Many companies issue a Statement of Stockholders Equity rather than the Statement of Retained Earnings. The Statement of Stockholders Equity is more inclusive and discloses changes in all equity accounts, not just Retained Earnings.
Matrix, Inc. Statement of Stockholders' Equity For the Year Ended December 31, 2010 Common stock and (In millions) capital in excess of par Shares Amount Balance at January 1, 2010 821 $ 2,500 Stock sales 17 500 Stock repurchases and retirement (17) (260) Cash dividends declared Other, net Net income Balance at December 31, 2010 821 $ 2,740 Retained Earnings $ 9,500 (925) (150) 70 5,100 $ 13,595

LO8

Total $ 12,000 500 (1,185) (150) 70 5,100 $ 16,335

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Learning Objective 9
Compute earnings per share and describe its use.

LO9

Basic Net income - Preferred dividends earnings = Weighted-average common shares outstanding per share

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LO10

Learning Objective 10
Compute price-earnings ratio and describe its use.

PE Ratio

Market price per common share = Earnings per share

This measure is often used by investors as a general guideline in gauging relative stock values.

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Learning Objective 11
Compute dividend yield and explain its use.

LO11

Dividend Annual cash dividends per share = Yield Market value per share

This ratio identifies the return, in terms of cash dividends, on the current market price of the stock.

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End of Chapter 21

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