BM1907

RETAINED EARNINGS
NATURE OF RETAINED EARNINGS
Retained earnings, otherwise known as accumulated profits, represent the cumulative balance of periodic net
income or loss, dividend distributions, prior period errors, changes in accounting policy, and other capital
adjustments (Valix, Peralta, & Valix, 2015).
An accumulated loss account or deficit happens when the retained earnings account has a debit balance. In
effect, this account decreases the shareholders’ equity of a corporation.
According to Valix, Peralta, and Valix (2015), there are two (2) kinds of retained earnings:
• Unappropriated retained earnings - These represent the portion which is free and can be declared as
dividends to shareholders.
• Appropriated retained earnings - These represent the portion which has been restricted and therefore not
available for dividend declaration.
The entry to appropriate retained earnings is:

Retained Earnings (Unappropriated Earnings) XXX

Appropriated Retained Earnings XXX
Note: The purpose of appropriation of retained earnings is to show that the amount appropriated is restricted
for any dividends distribution. Once the restriction is no longer needed, a reversing entry should be made in
the books of an entity.
ACCOUNTING FOR DIVIDENDS
Dividends are economic resources distributed by the company to its shareholders. It may be in the form of
cash, shares (stocks), or other properties. These dividends are the products of the company’s effort in
achieving superior performance for a particular period.
According to Asuncion, Ngina, and Escala (2017), dividends may be declared as either:
a. Dividends out of earnings; or
b. Dividends out of capital.
According to Trust Fund Doctrine, private corporations are prohibited from distributing its legal capital for the
protection of its creditors. The corporation is allowed only to distribute dividends out of its unrestricted
retained earnings.
Note: In any dividends distribution, only the outstanding shares are entitled to receive dividends. Outstanding
shares is computed as follows:
𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 = 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 + 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑏𝑏𝑏𝑏𝑏𝑏 − 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎*
* In computing for the amount of outstanding shares, treasury shares are deducted at par instead of its cost.
Important Dates in Dividends Distribution
• Date of declaration - It is the announcement of the board of directors (BOD) to distribute dividends to its
shareholder. On this date, the retained earnings account of the company is reduced by setting up this
entry:
Retained Earnings XXX
Dividends Payable XXX

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• Date of record - On this date, the corporation prepares the list of shareholders who are entitled to receive
dividends. No entry is required on this date.
• Date of settlement - On this date, the corporation pays all the liability for dividends by distributing either
cash or non-cash to its shareholders.

Dividends Payable XXX

Cash/Properties/Share Capital XXX
Forms of Dividends
Dividends can be in any of the following forms (Asuncion, Ngina, & Escala, 2017):
• Cash dividends - These can either be a certain amount of pesos per share or certain percent of par or
stated value.
• Property dividends - These are assets covered by IFRS 5 Non-Current Held for Sale and Discontinued
Operation (such as property, plant, and equipment, intangibles, and investment in associate) or other
assets not covered by IFRS 5 such as inventory, non-current assets covered by PAS 39 or IFRS 9, which
both discuss financial instruments. These should be measured at fair value of the assets to be distributed.
• Non-cash or cash alternative - It is where the entity gives the shareholder a choice of receiving non-cash
asset or a cash alternative. In this form of dividend, the entity shall estimate dividend payable by
considering both the fair value of each alternative and the associated probability of owners selecting each
alternative.
• Liability dividends - These items represent deferred cash dividend. This form of dividends may either be
scrip (for short-term) or bond (for long-term).
• Share dividends - These are dividends paid in the form of entity’s share. Shares of other entities declared
as dividends qualify as property dividends and not as share dividends. These can be classified as either
small or large.
The following should be observed in accounting for share dividends (Asuncion, Ngina, & Escala, 2017):
Small dividend Large dividend
Percentage declared Less than 20% of outstanding 20% or more of outstanding
shares shares
Amount to be charged to Fair value of the shares Par value of the shares
retained earnings
Amount credited to share Excess of fair value over par None
premium value

Illustrative Example 1: Cash Dividends

On September 1, 2X19, Bea Corporation’s BOD announces to distribute P3 per share dividends to all
outstanding shares of record on September 15. Bea’s capital transactions are as follows:
• Issued 20,000 ordinary shares at P50 par value on February 1, 2X19.
• Acquired and held in treasury, 3,000 ordinary shares at P75.
Bea Corporation then determines the outstanding shares as follows:

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Ordinary shares issued

Less: Treasury shares
Outstanding shares
Required: Provide the journal entries for the following dates:
1. Date of declaration 2. Date of record 3. Date of payment

Illustrative Example 2: Property Dividends

GA Corporation has unrestricted retained earnings balance of P2,000,000 on December 31, 2X19. On that
date, Gerald declared and distributed its investment property, which was carried under fair value model, as
property dividend. The investment property, which was acquired at a historical cost of P300,000, has a fair
market value of P450,000.
Required: At what amount should GA Corporation charge its retained earnings account as a result of property
divided declaration? ____________

Illustrative Example 3: Non-Cash or Cash Alternative

JB Corporation has 10 outstanding ordinary shares on January 1, 2X19. On December 31, 2X19, Julia declared
to issue dividends to the outstanding shareholders. The company gives the shareholders a choice to receive a
cash dividend of P20,000 per share or a property dividend in the form of non-cash asset. Each asset has a fair
value of P24,000. The company estimated that 70% of the shareholders would take option of the cash
dividend, and the remaining will choose to receive the non-cash asset.
The journal entry on December 31, 2X19 would be:

Retained Earnings __________

Dividends Payable __________
Solution:
Cash alternative (10 x __% x P20,000)
Add: Non-cash alternative (10 x __% x P24,000)
Total dividends
Illustrative Example 4: Liability Dividends
KC Corporation had sufficient retained earnings in 2X19 as a basis for dividends but was temporarily short of
cash. KC declared P1,000,000 dividends on July 1, 2X19 and issued promissory notes to its shareholders in lieu
of cash. The notes, which are dated July 1, 2X19, had a maturity date of June 30, 2X20 and a 10% interest rate.
How should KC account for the scrip dividends and related interest?
a) Debit Accumulated Profits and Losses for P1,100,00 on July 1, 2X19
b) Debit Accumulated Profits and Losses for P1,100,000 on June 30, 2X20
c) Debit Accumulated Profits and Losses for P1,100,000on July 1, 2X19 and debit interest expense for
P50,000 on December 31, 2X19
d) Debit Accumulated Profits and Losses for P1,000,000 on June 30, 2X20 and debit interest expense for
P50,000 on December 31, 2X19

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Illustrative Example 5: Share Dividends

The following are the components of Shareholders’ Equity of MS Corporation:
Ordinary share capital, 15,000 authorized shares, 10,000 shares issued and 750,000
outstanding, with P75 par value
Share premium 375,000
Retained earnings 375,000
Required: Assuming the market value of the shares is P100. Give the required entry if MS Corporation
declared:
a) 10% share dividend

b) 20% share dividend

Fractional Share Dividend

Issuance of share dividends might give rise to fractional share dividends for it might not be possible to issue
full shares to all shareholders (Asuncion, Ngina, & Escala, 2017).
For example, a shareholder owns 82 shares and the company declared 20% stock dividends. This shareholder
is entitled to receive 16 shares plus a fractional share of 2/5 share. A shareholder receiving the 2/5 share might
be issued warrants or rights and be given time to accumulate enough warrants for the acquisition of new
shares (Asuncion, Ngina, & Escala, 2017).

APPROPRIATION OF RETAINED EARNINGS

The appropriation of retained earnings refers to the restriction of retained earnings for a certain purpose. This
restriction is usually at the discretion of BOD or as mandated by the law or contract. Asuncion, Ngina, and
Escala (2017) discussed that appropriation can be any of the following:
• Legal appropriation - It is an appropriation of retained earnings as mandated by the law. An example
would be an appropriation for an amount equal to the cost of treasury share.
• Voluntary appropriation - It refers to an appropriation made by the management. Examples include:
a. Appropriation for plant expansion,
b. Appropriation for increase in working capital, and
c. Appropriation for contingencies.
• Contractual appropriation - It refers to an appropriation as required by the contract to ensure payment.
Such issuances may impose restriction on the payment of dividends. Examples include:
a. Appropriation for sinking fund or bond redemption, and
b. Appropriation for redemption of preference shares.

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STATEMENT OF RETAINED EARNINGS

The statement of retained earnings (retained earnings statement) is a financial statement that outlines the
changes in retained earnings for a company over a specified period (Tuovila, 2019). This statement reconciles
the beginning and ending retained earnings for the period, using information such as net income from the
other financial statements, and is used by analysts to understand how corporate profits are utilized (Tuovila,
2019).
Components of Statement of Retained Earnings
• Dividends
• Prior years’ retained earnings
• Appropriation of retained earnings
• Effect of errors and change in accounting policy
STATEMENT OF CHANGES IN EQUITY
The statement of changes in equity is a formal report that reconciles the beginning and the ending balance of
the shareholders’ equity during a reporting period. Although it is a statement, it is not included among those
basic financial statements for reporting purposes.

General format:
𝐸𝐸𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞𝑞 (𝑏𝑏𝑏𝑏𝑏𝑏) + 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡ℎ𝑒𝑒 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 + 𝑂𝑂𝑂𝑂ℎ𝑒𝑒𝑒𝑒 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎

Components of Statement of Changes in Equity

An entity shall present a statement of changes in equity showing the following (Valix, Peralta, & Valix, 2015):
a. Total comprehensive income for the period
b. For each component of equity, the effects of changes in accounting policies and corrections of errors
c. For each component of equity, a reconciliation between the carrying amount at the beginning and end of
the period, separately disclosing changes from:
1. Profit or loss
2. Each item of other comprehensive income
3. Transaction with owners in their capacity as owners showing separately contributions by and
distributions to owners
QUASI-REORGANIZATION
A quasi-reorganization is a permissive but not a mandatory procedure under which a financially troubled
entity restates its accounts and establishes a “fresh start” in accounting sense. Specifically, it is the procedure
of restating the assets, liabilities, and share capital balances in conformity with fair value to eliminate a deficit
(Valix, Peralta, & Valix, 2015).
Quasi-reorganization is also called corporate readjustment and may be accomplished through (Valix, Peralta,
& Valix, 2015):
1. Recapitalization, and
2. Revaluation of property, plant, and equipment.

References
Asuncion, D. J., Ngina, M. A., & Escala, R. F. (2017). Applied auditing. Pampanga: St. Thomas More College-Clark.
Tuovila, A. (2019). Statement of retained earnings. Retrieved September 3, 2019, from https://www.investopedia.com/terms/s/statement-of-retained-
earnings.asp
Valix, C. T., Peralta, J. F., & Valix, C. A. (2015). Financial accounting (Vol. 2). Manila: GIC Enterprises & Co., Inc.

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