Shareholders’ Equity

Retained Earnings
PROF. PAULINE KRISTINE M. FULGENCIO, CPA,
MBA
Retained Earnings
- Termed Accumulated Profits under IFRS.

- Represents the firm’s accumulated profit or loss,

including prior-period adjustments less the dividends
declared and other amounts transferred to the
contributed capital accounts.

- Normal balance: Credit.

 Retained Earnings
Current Loss
Dividends
Conversion of share capital
Treasury Share transactions
Retirement of Share Capital
Effects of recapitalization
Adjustments for correction of
prior-period errors (IAS 8)
Cumulative effect of change in
accounting policy (IAS 8)
Current profit
Adjustment for correction of
prior period errors
Cumulative effect of change in
accounting policy (IAS 8)
Quasi-reorganization
Revaluation surplus realized
Current Profit or Loss
• If the Profit or Loss Summary account has a credit balance
(indicating a profit) the entry is –

Profit or Loss Summary xx

Retained Earnings xx

• If the Profit or Loss Summary account has a debit balance

(indicating a loss) the entry is –

Retained Earnings xx
Profit or Loss Summary xx
Dividends
- A dividend is a distribution of corporate income to its
shareholders on a pro-rata basis.

- A dividend is generally considered to be a cash payment

issued to the holders of company stock. However, there are
several types of dividends, some of which do not involve the
payment of cash to shareholders.
Dividends
• Three important dates are noted in a formal dividend
announcement namely:

– Date of Declaration: This is the date when the Board of

Directors formally approves and announces the dividends.
– Date of Record: a list of current shareholders who will be
entitled to the dividend is prepared and the dividend
payment is based on this list.
– Date of Payment: an entry is made in the books to record
the settlement of the dividend either by payment of cash
or distribution of company’s own shares.
Types of Dividends
Cash Dividends
The most common type of dividend. When cash
dividends are declared, a current liability is recognized
in the accounts with a corresponding charge to
retained earnings or dividends account.
On February 1, ABC International's board of directors declares a
cash dividend of P 1.00 per share on the company's 1,000,000
outstanding shares, to be paid on June 1 to all shareholders of
record on April 1.

• On February 1, the • On June 1, ABC pays the

company records this entry: dividends, and records the
transaction with this entry:

Retained Earnings 1,000,000 Dividends Payable 1,000,000

Dividends payable 1,000,000 Cash 1,000,000
Types of Dividends
Property Dividends
A company may issue a non-monetary dividend to
investors, rather than making a cash or stock payment.
Record this distribution at the fair market value of the
assets distributed. Since the fair market value is likely
to vary somewhat from the book value of the assets,
the company will likely record the variance as a gain or
loss.
Assume that on October 15, 2013, the XYZ Corporation declared property dividends
distributable on March 31, 2014 in the form of pieces of equipment with carrying
value of P320,000 (cost-P500,000 and acc. Dep.- P180,000) and with fair value of
P350,000. On December 31, 2013, the equipment’s fair value slightly fell to
P340,000, and on March 31, 2014, the assets fair value increased to P370,000.

2013
Oct. 15. Retained Earnings 350,000
Property Dividends Payable 350,000
declaration of property dividends

15. Assets held for Distribution 320,000

Accumulated Depreciation 180,000
Equipment 500,000
Dec. 31. Property Dividends Payable 10,000
Retained Earnings 10,000
re-measurement of the liability at FMV of asset.

2014
Mar. 31. Retained Earnings 30,000
Property Dividends Payable 30,000

31. Property Dividends Payable 370,000

Assets Held For Distribution 320,000
Gain on Disposal of Assets 50,000
Types of Dividends
Share Dividends (Bonus Issue)
A stock dividend is the issuance by a company of its
common stock to its common shareholders without
any consideration. Unlike cash and property
dividends, a bonus issue does not affect total assets
and total shareholders’ equity because it simply
represents a transfer of capital from retained
earnings to contributed capital.
ABC International declares a stock dividend to its shareholders of
10,000 shares. The fair value of the stock is P5.00, and its par
value is P1. ABC records the following entry:
Retained Earnings 50,000
Common Stock, P1 par value 10,000
Additional Paid-in Capital 40,000

Consider the following illustration:

The complete structure of ABC Corporation at December 31, 2012:

Ordinary Share Capital, P10 par, 100,000 shares

issued and outstanding P1,000,000
Share Premium 200,000
Retained Earnings 900,000
Small Bonus Issue
On February 1, 2013, the board of directors declared a
15%`bonus issue distributable on March 31, 2014. The market
value per share on declaration date is P15.

2013
Feb. 1. Retained Earnings 225,000
Share Dividends Payable 150,000
Share Premium-Ordinary 75,000

Mar. 31. Share Dividends Distributable 150,000

Ordinary Share Capital 150,000
Large Bonus Issue
On February 1, 2013, the board of directors declared a 30%
bonus issue distributable on March 31, 2014. The market
value per share on declaration date is P15.

2013
Feb. 1. Retained Earnings 300,000
Share Dividends 300,000

2014
Mar. 31. Share Dividends Distributable 300,000
Ordinary Share Capital 300,000
Types of Dividends
Scrip Dividends
A company may not have sufficient funds to issue
dividends in the near future, so instead it issues a
scrip dividend, which is essentially a promissory note
(which may or may not include interest) to pay
shareholders at a later date. This dividend creates a
note payable.
ABC International declares a P250,000 scrip dividend to its
shareholders that has a 10 percent interest rate. At the dividend
declaration date, it records the following entry:
Retained Earnings 250,000
Notes Payable 250,000

The date of payment is one year later, so that ABC has accrued
$25,000 in interest expense on the notes payable. On the
payment date (assuming no prior accrual of the interest
expense), ABC records the payment transaction with this entry:

Notes Payable 250,000

Interest Expense 25,000
Cash 275,000
Types of Dividends
Liquidating Dividends
When the board of directors wishes to return the
capital originally contributed by shareholders as a
dividend, it is called a liquidating dividend, and may be
a precursor to shutting down the business. The
accounting for a liquidating dividend is similar to the
entries for a cash dividend, except that the funds are
considered to come from the additional paid-in capital
account.
ABC International's board of directors declares a liquidating
dividend of $1,600,000. The balance of Retained Earnings on this
date is P500,000 It records the dividend declaration with this
entry:

Retained Earnings 500,000

Additional Paid-in Capital 1,100,000
Dividends Payable 1,600,000

On the dividend payment date, ABC records the following entry

to record the payment transaction:

Dividends Payable 1,600,000

Cash 1,600,000
Allocation of Cash Dividends between
Preference Shares and Ordinary Shares
• Preference Shares have priority over ordinary shares in terms of
dividends. Thus, cash dividends must be paid to preference
shares before ordinary are paid any dividends.
a. Non-cumulative rights – if a dividend is not paid in a particular
year, the right to the dividend is lost.
b. Cumulative rights – If a dividend is not declared in a particular
year, the right to the dividend is not lost but carries out to the
subsequent years.
c. Nonparticipating rights – any remaining dividend goes to
ordinary shareholders.
d. Participating rights – ordinary shareholders will receive a like
percentage of par value outstanding.
Appropriation of Retained Earnings
An appropriation of retained earnings involves the establishment
of a formal policy by the board of directors whereby a portion
of retained earnings is earmarked for a designated purpose and
is unavailable for dividends.

The board of directors may appropriate retained

earnings for the following reasons:

• Legal requirements. The company should appropriate

retained earnings equal to the remaining costs of treasury
share.
• Contractual Agreement. Some bond indentures require
appropriation of retained earnings at a specified amount over
the term of the bond.

• Discretionary Actions. Management discretion including

planning for future expansion or in anticipation of potential
future losses.

• Protection of Working Capital. When it is necessary to

maintain a strong current position so the company must
disclose that the working capital is not available for dividend
declaration equal to the amount of appropriation.
Appropriation of Retained Earnings
May be accounted for by either of the following:
1) Prepare journal entry for the appropriation; or
2) Disclose the restrictions in a note accompanying the financial
statements or a parenthetical note in the shareholders’
equity section of the statement of financial position

Retained Earnings xx
Retained Earnings appropriated for
treasury shares xx
Appropriated retained earnings equal to the
cost of treasury shares.
Revaluation Surplus
• Revaluation of fixed assets is the process of increasing or decreasing
their carrying value in case of major changes in fair market value of
the fixed asset.

• The choice of the model used is applicable to an entire class of

property, plant and equipment and intangible assets.

• International Financial Reporting Standards (IFRS) require fixed assets

to be initially recorded at cost but they allow two models for
subsequent accounting for fixed assets, namely the cost model and
the revaluation model.
Cost Model
• In cost model the fixed assets are carried at their historical cost less accumulated
depreciation and accumulated impairment losses. There is no upward adjustment to value
due to changing circumstances.

e.g.
Axe Ltd. purchased a building worth P200,000 on January 1, 2008. It records the building using the following
journal entry.

Equipment 200,000
Cash 200,000

The building has a useful life of 20 years and the company uses straight line depreciation. Yearly
depreciation is hence P200,000/20 or P10,000. Accumulated depreciation as at December 31, 2010
is P10,000*3 or P30,000 and the carrying amount is P200,000 minus P30,000 which equals
P170,000.

We see that the building remains at its historical cost and is periodically depreciated with no other
upward adjustment to value.
Revaluation Model
• In revaluation model an asset is initially recorded at cost but subsequently its
carrying amount is increased to account for any appreciation in value. The
difference between cost model and revaluation model is that revaluation model
allows both downward and upward adjustment in value of an asset while cost
model allows only downward adjustment due to impairment loss.
e.g.
Consider the example of Axe Ltd. as quoted in case of cost model. Assume on
December 31, 2010 the company intends to switch to revaluation model and
carries out a revaluation exercise which estimates the fair value of the building to
be P190,000 as at December 31, 2010. The carrying amount at the date is
P170,000 and revalued amount is P190,000 so an upward adjustment of P20,000 is
required to building account. It is recorded through the following journal entry:

Building 20,000
Revaluation Surplus 20,000
Revaluation Surplus
• Upward revaluation is not considered a normal gain and is not recorded in
income statement rather it is directly credited to an equity account called
revaluation surplus. Revaluation surplus holds all the upward revaluations
of a company's assets until those assets are disposed of.
Depreciation After Revaluation
• The depreciation in periods after revaluation is based on the revalued
amount. In case of Axe Ltd. depreciation for 2011 shall be the new carrying
amount divided by the remaining useful life or P190,000/17 which equals
P11,176.
Reversal of Revaluation
• If a revalued asset is subsequently valued down due to impairment, the
loss is first written off against any balance available in the revaluation
surplus and if the loss exceeds the revaluation surplus balance of the same
asset the difference is charged to income statement as impairment loss.
Example
• Suppose on December 31, 2012 Axe Ltd. revalues the building
again to find out that the fair value should be $160,000.
Carrying amount as at December 31, 2012 is $190,000 minus
2 years depreciation of $22,352 which amounts to $167,648.

• The carrying amount exceeds the fair value by $7,648 so the

account balance should be reduced by that amount. We
already have a balance of $20,000 in the revaluation surplus
account related to the same building, so no impairment loss
shall go to income statement. The journal entry would be:

Revaluation Surplus 7,648

Building Account 7,648
Book Value per Share
• compares the amount of stockholders' equity to the number
of shares outstanding.
• this measure is a possible indicator of the value of a
company's stock.
• The measurement is rarely used internally; instead, it is used
by investors who are evaluating the price of a company's
stock.
• The formula is as follows:
__Total Shareholders’ Equity__
Number of Shares Outstanding
Book Value per Share
To illustrate, assume the following shareholders’ equity of ABC Corp.:

Ordinary Share Capital, P20 par (90,000 shares) 1,800,000

Subscribed Ordinary Share,P20 par, (10,000 shares) 200,000
Share Premium 550,000
Retained Earnings 1,200,000
Treasury Shares, 5,000 shares at cost 125,000

The book value per share is computed as follows:

Total Shareholders’ Equity 3,625,000
Number of Outstanding Shares ÷ 95,000
Book value per ordinary share 38.16