Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 21

Corporate

Earnings, Taxes,

and Distributions

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Learning Objective 1Compute and record corporate income tax.Taxable income

Less income taxes= Net income

Corporations pay taxes based on their taxable income.

Corporations pay taxes based on their taxable income.

× Tax Rate = Tax LiabilityLevel Amount

1st 50,000$ 15% 7,500$ 2nd 25,000 25% 6,250 3rd 25,000 34% 8,500 4th 110,000 39% 42,900

Total 210,000$ 65,150$

Taxable Income × Tax Rate = Tax LiabilityLevel Amount

1st 50,000$ 15% 7,500$ 2nd 25,000 25% 6,250 3rd 25,000 34% 8,500 4th 110,000 39% 42,900

Total 210,000$ 65,150$

Taxable Income

Surf Outlet expects taxable income of $210,000 for 2010.Its estimated tax liability is computed as follows:

Surf Outlet expects taxable income of $210,000 for 2010.Its estimated tax liability is computed as follows:

Apr. 15 Income Tax Expense 16,287.50 Cash (1/4 × $65,150) 16,287.50

Apr. 15 Income Tax Expense 16,287.50 Cash (1/4 × $65,150) 16,287.50

The entry to record the first quarterly payment on April 15 is:The entry to record the first quarterly payment on April 15 is:The entry to record the first quarterly payment on April 15 is:The entry to record the first quarterly payment on April 15 is:

LO1

Surf Outlet’s quarterly tax payments are $16,287.50 ($65,150/4 quarters). We record the entry for the first quarterly income tax payment on April 15 by debiting Income Tax Expense for $16,287.50 and crediting Cash for the same amount.

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Adjusting Tax Liability to Amount Owed Based on Actual Taxable Income

Tax payments made in 2010 65,150.00$ Tax liability in 2010 59,016.47 Tax refund 6,133.53$

Dec. 31 Income Tax Refund Receivable 6,133.53 Income Tax Expense 6,133.53

Dec. 31 Income Tax Refund Receivable 6,133.53 Income Tax Expense 6,133.53

The entry to record The entry to record the tax refund the tax refund receivable on receivable on

December 31 is:December 31 is:

The entry to record The entry to record the tax refund the tax refund receivable on receivable on

December 31 is:December 31 is:

Overpayment of Taxes

Underpayment of Taxes

Tax payments made in 2010 65,150.00$ Tax liability in 2010 66,586.37 Additional taxes owed (1,436.37)$

The entry to record the The entry to record the additional tax payable additional tax payable

on December 31 ison December 31 is

The entry to record the The entry to record the additional tax payable additional tax payable

on December 31 ison December 31 isDec. 31 Income Tax Expense 1,436.37

Income Tax Payable 1,436.37

Dec. 31 Income Tax Expense 1,436.37 Income Tax Payable 1,436.37

LO1

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Date of Declaration

Record liabilityfor dividend.

Dividends

Jan. 19 Retained Earnings 10,000 Common Dividend Payable 10,000 Declared $1 per share cash dividend

On January 19, a $1 per share cashOn January 19, a $1 per share cash dividend is declared on Dana, Inc.’s dividend is declared on Dana, Inc.’s 10,000 common shares outstanding.10,000 common shares outstanding.

The dividend will be paid on March 19The dividend will be paid on March 19to stockholders of record on February 19.to stockholders of record on February 19.

Date of Record

No entryrequired.

No entry required on February 19.

Learning Objective 2 Record transactions involving cash dividends.

LO2

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Date of Payment

Record payment ofcash to stockholders.

Mar. 19 Common Dividend Payable 10,000 Cash 10,000 Paid $1 per share cash dividend

Entries for Cash Dividends

On January 19, a $1 per share cashOn January 19, a $1 per share cash dividend is declared on Dana, Inc.’s dividend is declared on Dana, Inc.’s 10,000 common shares outstanding.10,000 common shares outstanding.

The dividend will be paid on March 19The dividend will be paid on March 19to stockholders of record on February 19.to stockholders of record on February 19.

LO2

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The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return.

The corporation distributes additional shares of its own stock to its stockholders without receiving any payment in return.

Why a stock dividend?

•Can be used to keep the market price of the stock affordable.

•Can provide evidence of management’s confidence that the company is doing well.

Why a stock dividend?

•Can be used to keep the market price of the stock affordable.

•Can provide evidence of management’s confidence that the company is doing well.

HotAir, Inc.Common Stock

100 shares

$1 par

Learning Objective 3Account for stock dividends and stock splits.

LO3

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Dec. 31 Retained Earnings 20,000 Common Stock Dividend Distributable 2,000 Paid-In Capital in Excess of Par Value 18,000 Declared a 2,000 share (2%) stock dividend

Recording a Small Stock DividendOn December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling forOn December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling for

$10 per share. The stock will be distributed to stockholders on January 20, 2011. Let’s make$10 per share. The stock will be distributed to stockholders on January 20, 2011. Let’s makethe December 31 entry.the December 31 entry.

On December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling forOn December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling for$10 per share. The stock will be distributed to stockholders on January 20, 2011. Let’s make$10 per share. The stock will be distributed to stockholders on January 20, 2011. Let’s make

the December 31 entry.the December 31 entry.

On December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling for$10 per share. The stock will be distributed to stockholders on January 20, 2011. Now let’s

make the January 20 entry.

On December 31, 2010, Quest declared a 2% stock dividend, when its stock was selling for$10 per share. The stock will be distributed to stockholders on January 20, 2011. Now let’s

make the January 20 entry.

LO3

Jan. 20 Common Stock Dividend Distributable 2,000 Common Stock, $1 Par Value 2,000 To record issuance of common stock dividend

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Recording a Large Stock DividendOn December 31, 2010, Router declared a 40% stock dividend, when its stock was

selling for $8 per share. State law requires that large stock dividends be capitalized at par value per share.

On December 31, 2010, Router declared a 40% stock dividend, when its stock was selling for $8 per share. State law requires that large stock dividends be capitalized at

par value per share.

LO3

A stock split is the distribution of additional shares to stockholders according to their percent ownership.

A 2-for-1 stock split replaces 100,000 shares of $20 par value stock with 200,000 shares of $10 par value stock. Market value is reduced from $88 per share to about $44 per share.

The split does not affect any balance sheet amounts or any individual stockholder’s percent ownership. Both the Paid-In Capital and Retained Earnings accounts are unchanged by a split, and no journal entry is made.

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Example: Consider the following Stockholders’ Equity Section of a Balance Sheet

Learning Objective 4Distribute dividends between common stock and preferred stock.

Dividend Preference of Preferred Stock

See how this dividend is distributed if the preferred stock is cumulative and if it is noncumulative.

LO4

If Preferred Stock is Noncumulative: Preferred CommonYear 2009: No dividends paid. -$ -$

Year 2010:1. Pay 2010 preferred dividend. 9,000$

2. Remainder goes to common. 33,000$

If Preferred Stock is Cumulative: Preferred CommonYear 2009: No dividends paid. -$ -$

Year 2010:1. Pay 2009 preferred dividend in arrears. 9,000$ 2. Pay 2010 preferred dividend. 9,000 3. Remainder goes to common. 24,000$ Totals 18,000$ 24,000$

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On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000.

On May 8, Whitt, Inc. purchased 2,000 of its own shares of stock in the open market for $8,000.

May 8 Treasury Stock, Common 8,000 Cash 8,000

Purchase 2,000 treasury shares

at $4 per share

Learning Objective 5Record purchases and sales of treasury stock.

Selling Treasury Stock at Cost On June 30, Whitt sold 100 shares of its treasury

stock for $4 per share. On June 30, Whitt sold 100 shares of its treasury

stock for $4 per share.

June 30 Cash 400 Treasury Stock, Common 400

Sold 100 shares of treasury

for $4 per share

LO5

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On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share.

On July 19, Whitt, Inc. sold an additional 500 shares of its treasury stock for $8 per share.

July 19 Cash 4,000 Treasury Stock, Common 2,000 Paid-In Capital, Treasury Stock 2,000 Sold 500 treasury shares for $8 per share

Selling Treasury Stock Above Cost

Selling Treasury Stock Below Cost

Aug. 27 Cash 600

1,000 Treasury stock, Common 1,600 Sold 400 treasury shares for $1.50 per share

Paid-in Capital, Treasury Stock

LO5

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Learning Objective 6Describe events that can affect retained earnings.

A corporation’s directors can voluntarily limit dividends because of a special need for cash such

as the purchase of new facilities.

A corporation’s directors can voluntarily limit dividends because of a special need for cash such

as the purchase of new facilities.

Retained earnings can have legal or contractual restrictions. In most states, the corporate charters will not allow companies to purchase treasury stock in excess of the balance in retained earnings.

Some loan agreements place restrictions on how much dividends can be based on the balance in retained earnings.

Some loan agreements place restrictions on how much dividends can be based on the balance in retained earnings.

LO6

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Learning Objective 7Prepare a statement of retained earnings.

The Statement of Retained Earnings is a summary of the activity that occurred in Retained Earnings during the periodThe Statement of Retained Earnings is a summary of the activity that occurred in Retained Earnings during the period

LO7

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(In millions) Retained

Shares Amount Earnings TotalBalance at January 1, 2010 821 2,500$ 9,500$ 12,000$ Stock sales 17 500 500 Stock repurchases and retirement (17) (260) (925) (1,185) Cash dividends declared (150) (150) Other, net 70 70 Net income 5,100 5,100 Balance at December 31, 2010 821 2,740$ 13,595$ 16,335$

Common stock and capital in excess of par

Matrix, Inc.

Statement of Stockholders' Equity

For the Year Ended December 31, 2010

(In millions) Retained

Shares Amount Earnings TotalBalance at January 1, 2010 821 2,500$ 9,500$ 12,000$ Stock sales 17 500 500 Stock repurchases and retirement (17) (260) (925) (1,185) Cash dividends declared (150) (150) Other, net 70 70 Net income 5,100 5,100 Balance at December 31, 2010 821 2,740$ 13,595$ 16,335$

Common stock and capital in excess of par

Matrix, Inc.

Statement of Stockholders' Equity

For the Year Ended December 31, 2010

Many companies issue a Statement of Stockholders’ Equity rather than the Statement of Retained Earnings. The Statement of Stockholders’ Equity is more inclusive and discloses changes in all equity accounts, not just Retained Earnings.

Learning Objective 8Prepare a statement of stockholders’ equity.

LO8

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Learning Objective 9Compute earnings per share and describe its use.

Basicearningsper share

= Net income - Preferred dividends Weighted-average common shares outstanding

LO9

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This measure is often used by investors as ageneral guideline in gauging relative stock values.

Learning Objective 10Compute price-earnings ratio and describe its use.

LO10

PERatio =

Market price per common shareEarnings per share

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Learning Objective 11Compute dividend yield and explain its use.

DividendYield

= Annual cash dividends per share

Market value per share

This ratio identifies the return, in terms of cashdividends, on the current market price of the

stock.

LO11

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End of Chapter 21