Chapter

12
INCOME AND CHANGES IN
RETAINED EARNINGS

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 Learning Objective
To distinguish
between basic and
diluted earnings per
share.

LO3
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 Basic and Diluted Earnings per Share
If a company has convertible securities,
like convertible preferred stock
outstanding, the conversion of these
securities to common stock may dilute
(reduce) earnings per share.

Diluted earnings per share reflect the

impact of the assumed conversion of
the securities on earnings.
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 Price-earnings Ratio (P/E)
Often, the Price-Earnings Ratio is used to evaluate
the reasonableness of a company’s stock price.

Let’s examine this

further.
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 Learning Objective
To account for cash
dividends and stock
dividends, and explain the
effects of these transactions
on a company’s financial
statements.

LO4
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 Accounting for Cash Dividends
Declared by Board Not legally
of Directors. required.

Requires sufficient
Creates liability
Retained Earnings
at declaration.
and Cash.
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 Dividend Dates
Date of Declaration
• Board of Directors declares the dividend.
• Record a liability.
On March 1, 2007, the Board of Directors of Matrix, Inc.
declares a $1.00 per share cash dividend on its 500,000
common shares outstanding. The dividend is payable to
stockholders of record on April 1, and paid on May 1.

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 Dividend Dates
Ex-Dividend Date
• The day which serves as the ownership
cut-off point for the receipt of the most
recently declared dividend.

NO ENTRY

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 Dividend Dates
Date of Record
• Stockholders holding shares on this date will
receive the dividend. (No entry)
April 2007
X

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 Dividend Dates
Date of Payment
• Record the payment of the dividend to
stockholders.

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 Dividend Dates
On June 1, 2007, a corporation’s board of
directors declared a dividend for the 2,500 shares
of its $100 par value, 8% preferred stock. The
dividend will be paid on July 15. Which of the
following will be included in the July 15 entry?

a. Debit Retained Earnings $20,000.

b. Debit Dividends Payable $20,000.
c. Credit Dividends Payable $20,000.
d. Credit Preferred Stock $20,000.
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 Accounting for Stock Dividends
Distribution of additional shares of stock to
stockholders.

No change in total No change in par

stockholders’ equity. values.

All stockholders
retain same
percentage
ownership.
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 Summary of Effects of Stock
Dividends and Stock Splits
Small Stock Large Stock
Stock Splits
Dividend Dividend
Total
Stockholders' No Effect No Effect No Effect
Equity
Common Stock Increases Increases No Effect
Paid-in Capital Increases No Effect No Effect
Retained Earnings Decreases Decreases No Effect
Number of Shares
Increases Increases Increases
Outstanding
Par Value per
No Effect No Effect Decreases
Share

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 Learning Objective
To describe and
prepare a statement
of retained earnings.

LO5
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 Statement of Retained Earnings
with Prior Period Adjustment

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 Restrictions of Retained Earnings
If I loan your company $1,000,000, I
will want you to restrict your
retained earnings in order to limit
dividend payments.

Loan agreements can include restrictions

on paying dividends below a certain
amount of retained earnings.

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 Learning Objective
To define prior period
adjustments, and explain
how they are presented
in financial statements.

LO6
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 Prior Period Adjustments
The correction of an error identified as
affecting net income in a prior period.

Adjust retained The adjustment

earnings retroactively. should be disclosed
net of any taxes.

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 Learning Objective
To define
comprehensive income,
and explain how it differs
from net income.

LO7
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 Comprehensive Income
Normally, there are 3 ways that financial
position can change.

Issuance of new Net Income or Payment of

shares of stock. Net Loss Dividends

GAAP excludes some unrealized items from

income, such as the change in market value of
available-for-sale debt and equity investments.

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 Comprehensive Income
GAAP requires that unrealized items that are normally reported
on the balance sheet be added back to compute
“Comprehensive Income.”

The accumulated amount of There are 3 options for

changes affecting reporting Comprehensive
Comprehensive Income is Income.
reported in equity.

As a second Combined with As an element of

Income Statement. Net Income on the Stockholders’
Income Statement. Equity.

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 Learning Objective
To describe and prepare a
statement of stockholders’
equity and the
stockholders’ equity
section of the balance
sheet.

LO8
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 Statement of Stockholders’ Equity

This is a more inclusive statement than

the statement of retained earnings.
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 Stockholders’ Equity Section of the
Balance Sheet

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 Learning Objective
To illustrate steps
management might take
to improve the
appearance of the
company’s net income.

LO9
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 Improving the Appearance of Income
Companies may take certain steps that are
intended to improve the appearance of its
financial performance in the financial
statements. The Securities and Exchange
Commission brought a series of
enforcement actions against certain
companies for taking these steps.

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Any Questions?

27
Thanks

28
 End of Chapter 12

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