2. DIVIDENDS
What are they?
• A dividend is a return of wealth by a
corporation to its shareholders on an
equal basis.
• Dividends may be in the form of
– Cash, or
– Shares
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3. CASH DIVIDENDS
Requirements
• For a cash dividend to occur, a
corporation must have:
1. Retained earnings,
2. Adequate cash, and
3. Declared dividends
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4. CASH DIVIDENDS
Preferred Shares vs. Common Shares
• Cash dividends must be paid to preferred
shareholders before any common
shareholders are paid.
• There are two kinds of preferred shares:
1. Cumulative: all past dividends (in arrears)
must be paid before common shareholders
get anything.
2. Non-cumulative: only the current year’s
dividend must be paid before common
shareholders get a dividend.
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5. Before After
Cash Dividend Cash Dividend
Shareholders’ equity
Contributed Capital
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
CASH DIVIDEND
The Effects
• On Jan. 1, this company declares a $0.50 dividend per
share (or $50,000 total) to all shareholders on record
Feb. 1. The dividend is paid Mar. 1.
• This dividend represents a “drawings” on the wealth of
the corporation, and is returned to the shareholders.
• After a cash dividend shareholder’s equity falls.
$200,000 $200,000
$600,000 $550,000
$800,000 $750,000
100,000 100,000
$8 $7.50
Date Particulars Debit Credit
Jan 1 Cash Dividends 50,000
Cash Dividends Payable 50,000
Note: Like Drawings, Dividends are closed to Retained earnings in the closing entries.
Cash Dividends Payable 50,000
Cash 50,000
Retained Earnings 50,000
Cash Dividends 50,000
Dec 31
Mar 1
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6. STOCK DIVIDENDS
The Effects
• A stock dividend is an equal distribution of
the corporation’s own shares to its
shareholders.
• Fair market value is usually the value
assigned to the dividend shares.
• The FMV is transferred from retained
earnings to share capital (legal capital).
Total equity, however, is unchanged.
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7. Before After
Stock Dividend Stock Dividend
Shareholders’ equity
Contributed Capital
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
STOCK DIVIDEND
The Effects
• On Jan. 1 a company issues an additional 10,000 shares of common
stock proportionally to current shareholders on record as of Feb. 1. The
Stock is issued Mar. 1. Fair market value is $90,000.
• This value is now part of legal capital and must be transferred there
from retained earnings.
• Note how total shareholders’ equity will remain the same.
• The number of shares increases and this means that the book value per
share decreases.
$200,000 $290,000
$600,000 $510,000
$800,000 $800,000
100,000 110,000
$8 $7.27
Date Particulars Debit Credit
Jan 1 Stock Dividends 90,000
Stock Dividends Distributable 90,000
Stock Dividends Distributable 90,000
Common Stock 90,000
Retained Earnings 90,000
Stock Dividends 90,000
Dec 31
Mar 1
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8. • For company
– Satisfies dividend expectations without spending
cash
– Increases marketability of its shares by increasing
number and decreasing price
• For shareholder
– More shares with which to earn additional
dividend income
– More shares for future profitable resale, as share
price climbs again
STOCK DIVIDENDS
Purposes and Benefits
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9. STOCK SPLITS
The Effects
• A stock split involves the issue of additional
shares to shareholders according to their current
ownership percentage.
• A stock split has no effect on equity, or ownership
control, and therefore requires no journal entry.
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10. Before After
Stock Split Stock Split
Shareholders’ equity
Contributed Capital
Retained earnings
Total shareholders’ equity
Issued shares
Book value per share
STOCK SPLIT
The Effects
• Only the number of shares and book value per share
change.
• Observe the following 2-for-1 stock split:
$200,000 $200,000
$600,000 $600,000
$800,000 $800,000
100,000 200,000
$8 $4
Date Particulars Debit Credit
Dec 31
There is no journal entry since nothing of financial value changes.
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11. DIVIDENDS
A Summary of Effects
Stock Stock Cash
Split Dividend Dividend
Total assets NE NE
Total liabilities NE NE NE
Total shareholders’ equity NE NE
Total share capital NE NE
Total retained earnings NE
Legal capital per share NE NE
Book value per share
Number of shares NE
% of shareholder ownership NE NE NE
NE = No effect = Increase = Decrease
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12. RETAINED EARNINGS
Prior Period Adjustments
• A prior period adjustment results from:
1. The correction of a material error
– Occurs after the books are closed, and relates to a
prior accounting period.
2. Changing an accounting principle.
– Occurs when the principle used in the current year
is different from the one used in the preceding
years.
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13. RETAINED EARNINGS
Prior Period Adjustments
• The cumulative effect of the correction or
change (net of income tax) should be
1. Made directly to Retained Earnings;
2. Reported in the current year’s retained earnings
section as an adjustment of the beginning balance
of Retained Earnings;
3. Disclosed in a footnote to the financial statements;
4. Corrected and restated in all prior period financial
statements presented.
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14. RETAINED EARNINGS
Prior Period Adjustments
Shareholder’s Equity
Contributed Capital
Total Contributed Capital
Retained Earnings
Retained Earnings, January 1st as adjusted
Add: Net Income
Less: Cash Dividends
Change in Retained Earnings for the period.
Retained Earnings, December 31st
Total Shareholder’s Equity
$30,000
$39,000
$150,000
(80,000)
70,000
109,000
$139,000
Less: Correction of $10,000 overstated Net Income
due to excess recorded sales in prior year less $4,000
of income tax (40% tax rate)
Cumulative effect of a change in accounting
principle net of $10,000 tax expense
$(6,000)
$15,000 $9,000
Retained Earnings, January 1st as previously reported $30,000
Less: Stock Dividends (20,000)
$50,000
$50,000
$89,000
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15. Retained Earnings
RETAINED EARNINGS
Summary Of Things That Affect It
Debits (Decreases) Credits (Increases)
1. Correction of a prior period
error that overstated income
2. Cumulative effect of a
change in accounting
principle that decreased
income
3. Net loss
4. Cash dividends
5. Stock dividends
1. Correction of a prior period
error that understated
income
2. Cumulative effect of a
change in accounting
principle that increased
income
3. Net income
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16. EARNINGS PER SHARE
• Earnings per share (EPS) indicates the net
income earned by each common share.
• Companies report earnings per share on
the income statement
• The formula to calculate earnings per
share when there has been no change in
shares during the year is as follows:
Net Income –
Preferred Dividends
Number of
Common Shares
Earnings per
Share
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17. PRICE - EARNINGS RATIO
The price-earnings (P/E) ratio helps investors determine
whether the shares are a good investment in relation to
earnings. It is a per share calculation, calculated by dividing
the market price of the shares by its earnings per share.
A high P/E ratio can be one indicator that investors believe the
company has future growth potential.
Market price
per share
Earnings
per share
Price-Earnings
Ratio
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