Intermediate ch 18

Ownership interests of shareholders arise primarily from two sources

(1) amounts invested by shareholders in the corporation and (2) amounts earned by the corporation on behalf of its shareholders. These two sources are reported as (1) paid-in capital and (2) retained earnings.

Retained Earnings Restrictions

- Sometimes the amount available for dividends purposely is reduced by management. A restriction of retained earnings designates a portion of the balance in retained earnings as being unavailable for dividends. - might restrict retained earnings to indicate management's intention to withhold for some specific purpose the assets represented by that portion of the retained earnings balance.

Stock Splits

- A frequent reason for issuing a stock dividend is actually to induce the per share market price decline that follows. - The motivation for reducing the per share market price is to increase the stock's marketability by making it attractive to a larger number of potential investors.

liquidating dividend

- In unusual instances in which a dividend exceeds the balance in retained earnings, the excess is referred to as a liquidating dividend because some of the invested capital is being liquidated - might occur when a corporation is being dissolved and assets (not subject to a superior claim by creditors) are distributed to shareholders.

Property Dividends

- When a noncash asset is distributed - (often called a dividend in kind or a nonreciprocal transfer to owners). - The fair value of the assets to be distributed is the amount recorded for a property dividend. - Securities held as investments are the assets most often distributed in a property dividend due to the relative ease of dividing these assets among shareholders and determining their fair values.

Characteristics of Retained Earnings

- retained earnings represents a corporation's accumulated, undistributed net income (or net loss). A more descriptive title used by some companies is reinvested earnings. - A credit balance in this account indicates a dollar amount of assets previously earned by the firm but not distributed as dividends to shareholders

date of record.

A specific date is stated as to when the determination will be made of the recipients of the dividend - Registered owners of shares of stock on this date are entitled to receive the dividend—even if they sell those shares prior to the actual cash payment

Because cash is the asset most easily divided and distributed to shareholders, most corporate dividends are cash dividends

In concept, though, any asset can be distributed to shareholders as a dividend

most of the discussion in this chapter centers on par value shares

Largely, this means only that proceeds from shareholders' investment is allocated between stated capital and additional paid-in capital.

Cash Dividends

No such legal obligation exists for paying dividends to shareholders. A liability is not recorded until a company's board of directors votes to declare a dividend. In practice, though, corporations ordinarily try to maintain a stable dividend pattern over time.

To be a registered owner of shares on the date of record, an investor must purchase the shares before the ex-dividend date.

This date usually is two business days before the date of record. Shares purchased on or after that date are purchased ex dividend—without the right to receive the declared dividend.

A property dividend should be recorded at the fair value of the assets to be distributed, measured at the date of declaration

This may require revaluing the asset to fair value prior to recording the dividend. If so, a gain or loss is recognized for the difference between book value and fair value

Preferred shares may be cumulative or noncumulative.

Typically, preferred shares are cumulative, which means that if the specified dividend is not paid for a given year, the unpaid dividends (called dividends in arrears) accumulate and must be made up in a later dividend year before any dividends are paid on common shares

deficit

We refer to a debit balance in retained earnings as a deficit

A stock distribution of 25% or higher can be accounted for in one of two ways: (1) as a "large" stock dividend or (2) as a stock split.

a 100% stock dividend could be labeled a 2-for-1 stock split and accounted for as such. Conceptually, the proper accounting treatment of a stock distribution is to make no journal entry. This, in fact, is the prescribed accounting treatment for a stock split.

Be sure to understand that the restriction itself does not set aside cash for the designated event

but merely communicates management's intention not to distribute the stated amount as a dividend. - normally is indicated by a disclosure note to the financial statements. - Although instances are rare, a formal journal entry may be used to reclassify a portion of retained earnings to an "appropriated" retained earnings account

Paid-in capital

consists primarily of amounts invested by shareholders when they purchase shares of stock from the corporation or arise from the company buying back some of those shares or from share-based compensation activities.

Accumulated Other Comprehensive Income

events that are not included in net income and so don't affect retained earnings but are part of "other comprehensive income" and therefore are included as a separate component of shareholders' equity, accumulated comprehensive income

The four classifications within shareholders' equity

paid-in capital, retained earnings, accumulated other comprehensive income, and treasury stock.

The prescribed accounting treatment of a stock dividend requires that

shareholders' equity items be reclassified by reducing one or more shareholders' equity accounts and simultaneously increasing one or more paid-in capital accounts. - The amount reclassified depends on the size of the stock dividend.

Stock Dividends

the distribution of additional shares of stock to current shareholders of the corporation. - A stock dividend affects neither the assets nor the liabilities of the firm. - because each shareholder receives the same percentage increase in shares, shareholders' proportional interest in (percentage ownership of) the firm remains unchanged

If dividends are paid that exceed the amount of assets earned by the company

then management is, in effect, returning to shareholders a portion of their investments, rather than providing them a return on that investment. So most companies view retained earnings as the amount available for dividends

shareholders' equity

those accounts that represent the ownership interests of shareholders.

Alternatively, a redemption privilege might allow preferred shareholders the option

under specified conditions, to return their shares for a predetermined redemption price.

To avoid changing the per share par value of the shares,

the stock distribution is referred to as a stock split effected in the form of a stock dividend, or simply a stock dividend. - a journal entry increases the common stock account by the par value of the additional shares. To avoid reducing retained earnings in these instances, most companies reduce (debit) paid-in capital—excess of par to offset the credit to common stock

Comprehensive income

the total nonowner change in equity for a reporting period. - encompasses all changes in equity other than those from transactions with owners. - Comprehensive income includes net income as well as other gains, losses, and other adjustments that change shareholders' equity but are not included in traditional net income.

A company may be organized in any of three ways:

(1) a sole proprietorship, (2) a partnership, or (3) a corporation

Dividends

- One way a corporation provides a return to its shareholders on their investments is to pay them a dividend, typically cash - One way a corporation provides a return to its shareholders on their investments is to pay them a dividend, typically cash

The Concept of Par Value

- Par value originally indicated the real value of shares. All shares were issued at that price. - laws pertaining to par value and legal capital not only are bewildering but fail in their intent to safeguard creditors from payments to shareholders. - the concepts of par value and legal capital have been eliminated entirely from the Model Business Corporation Act

REVERSE STOCK SPLIT.

occurs when a company decreases, rather than increases, its outstanding shares. After a 1-for-4 reverse stock split, for example, 100 million shares, $1 par per share, would become 25 million shares, $4 par per share. No journal entry is necessary. Of course the market price per share theoretically would quadruple, which usually is the motivation for declaring a reverse stock split

Preferred shares may be participating or nonparticipating.

participating feature allows preferred shareholders to receive additional dividends beyond the stated amount. If the preferred shares are fully participating, the distribution of dividends to common and preferred shareholders is a pro rata allocation based on the relative par value amounts of common and preferred stock outstanding.

When directors declare a cash dividend,

we reduce retained earnings and record a liability.

Shareholders' equity is a residual amount

what's left over after creditor claims have been subtracted from assets (in other words, net assets)

Preferred shareholders sometimes have the right of conversion

which allows them to exchange shares of preferred stock for common stock at a specified conversion ratio.