Profit and changes in retained earnings
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Profit and Changes in Retained Earnings. Chapter 12. Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect profit. 1. Results of discontinued operations. 2. Impact of extraordinary items. Reporting the Results of Operations.

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Profit and Changes in Retained Earnings

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Profit and changes in retained earnings

Profit and Changes inRetained Earnings

Chapter 12


Reporting the results of operations

Normal, recurring revenue and expense transactions.

Unusual, nonrecurring events that affect profit.

1. Results of discontinued operations.

2. Impact of extraordinary items.

Reporting the Results of Operations

Information about profit can be divided into two major categories

Profit from continuing operations.


Profit and changes in retained earnings

This tax expense does not include effects of unusual, nonrecurring items.

These unusual, nonrecurring items are each reported net of taxes.


Discontinued operations

Profit/Loss from operating the operation prior to disposal.

Profit/Loss on disposal of the operation.

Discontinued Operations

When management enters into a formal plan to sell or discontinue a component of a company, the related gains and losses must be disclosed on the income statement.

Discontinued Operations


Discontinued operations1

Discontinued Operations

When management enters into a formal plan to sell or discontinue a component of a company, the related gains and losses must be disclosed on the income statement.

Acomponent is operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity.


Discontinued operations2

Discontinued Operations

During 2009, Matrix Limited sold an unprofitable component of the company. The component had a loss from operations during the period of $150,000 and a loss on the sale of its assets of $100,000. Matrix reported profit from continuing operations of $1,750,000. All items are taxed at 30%.

How will this appear on the income statement?


Discontinued operations3

Discontinued Operations


Discontinued operations4

Discontinued Operations

Income Statement Presentation:


Extraordinary items

Material in amount.

Gains or losses that are both unusual in nature and not expected to recur in the foreseeable future.

As many companies abused it, the IASB has prohibited presentation or disclosure of extraordinary items.

Some countries or places, e.g. US, still allow such presentation

Extraordinary Items


Earnings per share eps

Earnings Per Share (EPS)

A measure of the company’s profitability and earning power for the period.

Based on the number of shares issued and the length of time that number remained unchanged.


Earnings per share eps1

Earnings Per Share (EPS)

Remember that Matrix Limited has profit from continuing operations of $1,750,000. The after-tax loss from discontinued operations was $175,000. Assume that Matrix has 156,250 weighted average shares outstanding.

Let’s prepare a partial income statement using all this information.


Earnings per share eps2

Earnings Per Share (EPS)

$1,750,000 ÷ 156,250

* Rounded.


Earnings per share eps3

Earnings

Profit

-

Preference Dividends

=

Weighted Average Number of

Per Share

Ordinary Shares Outstanding

Earnings Per Share (EPS)

If preference share is present, subtract preference dividends from profit prior to computing EPS.

EPS is required to be reported in the income statement.


Other comprehensive income

Issuance of new shares.

Profit orLoss

Payment of Dividends

Other Comprehensive Income

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

IFRS excludessome unrealized items from profit, such as the change in market value of available-for-sale debt and equity investments.


Other comprehensive income1

The total of profit and other comprehensive income for the year is termed as total comprehensive income.

There are 2 options for reporting Other Comprehensive Income.

Combined with Profit on the Income Statement.

As a second Income Statement

Other Comprehensive Income

IFRS requires that certain unrealized items that are recognized in equity in the balance sheet be added back to compute “Other Comprehensive Income.”

The statement can then be termed as Statement of Comprehensive Income


Other comprehensive income2

Other Comprehensive Income


Cash dividends

Cash Dividends

Declared by Board of Directors.

Not legally

required.

Requires sufficient Retained Earnings and Cash.

Creates liability at declaration.


Dividend dates

Date of Declaration

Board of Directors declares the dividend.

Record a liability.

Dividend Dates

On 1 March 2009, the Board of Directors of Matrix Limited declares a $1.00 per share cash dividend on its 500,000 ordinary shares outstanding.

The dividend is payable to shareholders of record on 1 April, and paid on 1 May.


Dividend dates1

Ex-DividendDate

The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend.

Dividend Dates

NO ENTRY


Dividend dates2

April 2009

X

Dividend Dates

  • Date ofRecord

    • Shareholders holding shares on this date will receive the dividend.(No entry)


Dividend dates3

Dividend Dates

  • Date of Payment

    • Record the payment of the dividend to shareholders.


Dividend dates4

Dividend Dates

On 1 June 2009, a corporation’s board of directors declared a dividend for the 2,500 shares of its $100 par value, 8% preference share. The dividend will be paid on 15 July. Which of the following will be included in the 15 July entry?

a. Debit Retained Earnings $20,000.

b. Debit Dividends Payable $20,000.

c. Credit Dividends Payable $20,000.

d. Credit Preference share $20,000.

$100 × 8% = $8 dividend per share

$8 × 2,500 = $20,000 total dividend


Stock dividends

No change in total shareholders’ equity.

No change in par values.

Stock Dividends

Distribution of additional shares to shareholders.

All shareholders retain same percentage ownership.


Entries to record stock dividends

Entries to RecordStock Dividends

In accounting for a relatively small stock dividend (say, less than 20%), the market value of the new shares is transferred from Retained Earning account to the share premium accounts. This process is sometimes called “capitalizing” retained earnings.

On 1 June, Aspen Corporation has outstanding 1,000,000 shares of $1 par value ordinary share with a market value of $25 per share. The company declares a 5% stock dividend on this date. The dividend is distributable on 15 July to shareholders of record on 20 June. Let’s look at the journal entries.


Entries to record stock dividends1

Entries to RecordStock Dividends


Dividend dates5

Date of Declaration

Board of Directors declares the dividend.

Do not record a liability.

Dividend Dates

500,000 shares × $1 par value


Dividend dates6

Ex-DividendDate

The day which serves as the ownership cut-off point for the receipt of the most recently declared dividend.

Dividend Dates

NO ENTRY


Dividend dates7

June 2009

X

Dividend Dates

  • Date ofRecord

    • Shareholders holding shares on this date will receive the dividend.(No entry)


Dividend dates8

Dividend Dates

  • Date of Payment

    • Record the payment of the dividend to shareholders.


Reasons for stock dividends

Reasons for Stock Dividends

Management often finds stock dividends appealing because they allow management to distribute something of perceived value to shareholders while conserving cash which may be needed for other purposes.

Shareholders like stock dividends because they receive more shares, often the share price does not fall proportionately, and the dividend is not subject to income taxes (until the shares received are sold).


Distinction between share splits and stock dividends

Distinction between Share Splits and Stock Dividends

The difference between a stock dividend and a share split lies in the intent of management and the related issue of the size of the distribution. A stock dividend usually is intended to substitute for a cash dividend and is small enough that the market price of the share is relatively unaffected.

Stock dividends do not result in a change in the par value of the share. On the other hand, share splits result in a pro rata reduction in the par value of the share.


Summary of effects of stock dividends and share splits

Summary of Effects of Stock Dividends and Share Splits


Retrospective application and retrospective restatement

The adjustment should be disclosed net of any taxes.

Adjust retained earnings retroactively.

Retrospective Application and Retrospective Restatement

  • Change in accounting policy retrospective application (unless specified by IFRS)

  • Correction of error (prior period error) retrospective restatement


Restrictions of retained earnings

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.


Statement of changes in equity

Statement of Changes in Equity


Shareholders equity section of the balance sheet

Shareholders’ Equity Section of the Balance Sheet


End of chapter 12

End of Chapter 12


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