CHAPTER 8

RETAIN EARNINGS
(ACCUMULATED PROFITS)
When the revenues earned are more - It is credited for the amount of
than the costs and expenses incurred the net income and debited with
the result is a net income which the net loss. It is also debited
increases retained earnings as well as when dividends are declared.
the corporate resources. - It is however possible for a
- It also means more dividends debit balance or deficit to occur
can be distributed, issued when for a number of years the
stocks repurchased, and corporation has been incurring
corporate growth and heavy losses.
expansion.
Pro-forma journal entries of retained
The shareholder’s equity shows two earnings
rights over the corporate assets: 1. The net income is closed to
1. Right over contributed capital or retained earnings:
shareholder’s investment. Income Summary
2. Right over earned capital or Retained Earnings
retained earnings. To record net income for the
year.
Why is the retained earnings not
directly added to contributed capital 2. The net loss is closed to retained
like in a Partnership? earnings:
 The RCC requires a corporation Retained Earnings
to maintain separately its Income Summary
contributed capital from retained To record net loss for the year.
earnings since contributed capital
represents legal capital which In T account Form, posting of
cannot be taken out from the Retained Earnings:
corporation without special legal Dr. Cr.
action. (Trust Fund Doctrine)  Net loss for  Net Income
the period for the period
RETAINED EARNINGS  Dividends  Reversal of
 Are also called the surplus profits  Appropriate appropriation
of a corporation. Reserves reserves
 Represents the accumulated
profits that can be distributed as DIVIDENDS
dividends to the shareholders in  It is the decision to distribute
the lifetime of the corporation. profits in the form of dividends
 It is the balance of accumulated which rests with the Board of
yearly net income and losses less Directors.
the dividend distributions, after
income adjustments for prior
period errors and changes in
accounting policies are made.
 The normal balance of retained
earnings is credit.
 CHAPTER 8
RETAIN EARNINGS
(ACCUMULATED PROFITS)
Exception of the rule: when
KINDS OF DIVIDENDS there is a reason for restricting its
1. Dividends out of earnings/ distribution such as for plant
Ordinary Dividends expansion or for treasury shares.
2. Dividends out of Capital/ In this case, an appropriation of
Liquidating dividends. retained earnings should be set
up to limit or restrict the retained
ORDINARY DIVIDENDS/DIVIDENDS earnings amount.
OUT OF EARNINGS
- Dividends that are distributed (Appropriated/ Reserve Retained
periodically based on Earnings – a related amount of
accumulated earnings or retained earnings should be
retained earnings. reserved and not made available
- Distribution of earnings or for distribution.)
dividends to the shareholders
are based on the number of Who are entitled to Dividends?
shares held by them Section 42
 All outstanding capital stock are
Legally, only the retained earnings entitled to dividends.
may be distributed as dividends - OCS is the total shares of
and that there must be sufficient stocks issued to subscribers or
retained earnings to cover the shareholders, whether fully or
amount of dividends declared by partially paid, except for
the BOD. (Section 42 treasury shares. (Sec 137)
 Holders of subscribed shares that
Sec. 42 of RCC – no corporation are not delinquent shall have all
shall make or declare dividends the rights of a shareholder.
except from the surplus profits
(unrestricted/unappropriated Additionally in Sec 42
retained earnings) arising from the  Subscribed shares may be
business. given cash dividends, but cash
dividends will applied first to the
Additionally, it was further stated unpaid balance
that “stock corporations are  In Delinquent shares, the cash
prohibited from retaining surplus dividends will applied first to the
profits excess of 100% of their unpaid balance including its
paid in capital except when advertising costs expenses
justified by the circumstances”
 If it is stock dividend, it shall be
- For example, P1,000,000 is
withheld until the subscription is
the paid in capital and
fully paid.
retained earnings is P
1,500,000. The excess of
500,000 must be
distributed as dividends.
 CHAPTER 8
RETAIN EARNINGS
(ACCUMULATED PROFITS)
Dividends should be formally Pro Forma Entry for date of
declared: declaration:
1. Date of Declaration Retained Earnings
- This is the date when the Cash Dividends Payable
dividends are formally declared
by the Board. On this date, a Pro Forma Entry for date of
liability to distribute dividends distribution:
should be recognized in the Cash Dividends Payable
corporate books as follows: Cash
Retained Earnings
Dividends Payable Note: Cash dividends must be
declared:
2. Date of Record 1. when there is sufficient
- This is the date when, based on unrestricted profits
the stock and transfer book, the 2. when there is sufficient cash
corporation determines the
shareholders who will be Note: Dividends during the year
entitled to the dividends. No may be debited to a temporary title
journal entry is required on this called Dividends. However at the
date. end of the year, this account must
still be closed to the Retained
3. Date of Distribution Earnings.
- This is the date the dividends
are actually distributed to the Property Dividends
shareholders. - A distribution to shareholders
Dividends Payable that is payable in non-cash
Cash, Property, or share assets
capital. - Should be measured in the Fair
Value of the assets to be
FORMS OF ORDINARY DIVIDENDS distributed.
Cash Dividend
- The most common type of Pro Forma Entry for date of
dividend. declaration:
- The use of the term dividend Retained Earnings
without qualifications would Property Dividends Payable
mean a cash dividend
- It is usually expressed at a Pro Forma Entry for date of
certain amount of peso per distribution:
share Property Dividends Payable
- Or it is expressed at a certain Investment in xxx
percentage of the par value or
stated value
 CHAPTER 8
RETAIN EARNINGS
(ACCUMULATED PROFITS)
Liability Dividends and decreases the retained
- A deferred cash dividend earnings. Thus, total
payable in some future time shareholder’s equity is
because at the time of the unchanged)
dividend declaration cash is - SEC ruling permits the
unavailable. distribution of stock dividends
- A “scrip” or a written promise to also from additional paid in
pay at a certain future date is capital such as the Share
given to a shareholder. Premium.
- Usually, additional interest is - This dividend is usually
paid by the corporation for the expressed at a certain
waiting period from the date of percentage of the shares
declaration to date of payment. issued and subscribed.
- A bond is another form of
liability dividends. The only Effect of the Stock Dividends to
difference of the two is that the SH
bond is usually payable for a  From the shareholder pov,
longer period of time, say five when they receive the stock
years. dividends, only a
memorandum entry is
Pro Forma Entry for date of prepared in their books.
declaration:  A stock dividend does not
Retained Earnings change their percentage
Scrip Dividends Payable interests in the corporation
although total outstanding
Pro Forma Entry for date of shares have increased.
distribution:
Scrip Dividends Payable Should it be at par value or fair
Interest Expense market value?
Cash a. If the issuance of additional
shares is less than 20%, it is
considered a small stock
Stock Dividends dividend thus can be charged
- Distribution of the corporation’s to retained earnings at the fair
own stock coming from the market value, creating an
unissued shares. additional paid in capital.
- It is different from cash and b. If the issuance of additional
property dividends because shares is more than 20% or
share dividends do not transfer more, it is considered large
assets to the shareholders. The stock dividend thus should be
corporation retain its assets. charged to retained earnings at
- This type of dividend affects the par value.
only the accounts within the
shareholders’ equity (it Pro Forma Entry for date of
increases the total share capital declaration:
 CHAPTER 8
RETAIN EARNINGS
(ACCUMULATED PROFITS)
Retained Earnings a. When the corporation is
Stock Dividends for Distribution under dissolution and
liquidation
Pro Forma Entry for date of b. When the corporation is
distribution: engaged in exploration of
Stock Dividends for Distribution natural resources.
Share Capital
EARNINGS PER SHARE
 It is the amount of income earned
DIVIDENDS PAID TO PREFERRED for each share held by the
AND COMMON SHAREHOLDERS shareholders.
(See page 210-211)  A relevant information used in
When dividends are declared, the evaluating business performance
preferred shares will have preferential and estimating the earnings
treatment based on the priorities potential of a corporation.
enjoyed by their stocks.  An important factor in determining
 If stock is cumulative, previous the attractiveness of the common
dividends not declared will stock and in deciding the stock’s
automatically be included as soon market value.
as there is a declaration. - Market value is the price at
- It means dividends in arrears which a share of stock is
including current dividends of bought or sold in the open
the year will be distributed to market such as Philippine
them. Stock Exchange
 If stock is participating, aside - The price is shown in four
from the dividends computed columns:
based on dividend rate, they will a. Open - as the starting price
also receive a pro rata distribution for the day
on the remaining dividends b. Close - which is the ending
together with the common price for the day.
shareholder. c. High and Low represent the
Note: Cumulative and participating is peak price and the lowest
not implied, these must be specifically price of the stock.
stated.
Accounting for EPS
LIQUIDATING DIVIDENDS See page 212-213
- They are not distributions of  If the corporation is issuing only
earnings but rather returns of one kind of stock, earnings per
capital to the investing share or EPS is simply computed
shareholders. by dividing net income by the
- This type of dividend can be number of outstanding ordinary
legally paid only under either of shares.
the ff. circumstances:  If the corporation is issuing two
classes of stock, deduct first the
right of the preference shares in
 CHAPTER 8
RETAIN EARNINGS
(ACCUMULATED PROFITS)
the net income before computing distribution of the retained
for the EPS of the ordinary earnings, an appropriation must
shares. be set up.

ASSESSING ATTRACTIVENESS OF Entry

STOCK Retained Earnings
See page 213 Appropriation Reserve for xxx
1. Earnings per share
- Net income/EPS Note: an appropriation is still a retained
earnings, only that now it is not available
2. Price-Earnings ratio for dividends.
- Market Value/EPS
Other appropriations usually created
3. Return on Equity are as follows:
- Net Income/ Ordinary 1. Appropriation for Contingencies
Shareholder’s Equity - If the company has a pending
lawsuits which is probable of
losing, thus resources must be
BOOK VALUE PER SHARE available to meet such
See page 214-216 contingency in case the
 Represents the equity or right of company will be liable to pay in
a shareholder (expressed in peso the future.
share) in the assets of the
corporation. 2. Appropriation for Plant Expansion
 If the business is liquidated, this - If there is a plan to acquire land
will represent the amount of or plant facilities, thus
assets to be paid on each share resources must be available for
held by a shareholder. such project

3. Appropriation for Bonds and

APPROPRIATION OF RETAINED Stock Redemption
EARNINGS - If there is a provision in the
Retained Earnings are divided into: bond issue or stock issue, that
a) Free or Unappropriated Retained an equal amount of retained
Earnings earnings be appropriated, thus
b) Restricted or Appropriated resources must be set aside to
Retained Earnings ensure the eventual payment of
the bonds or redemption of the
Unless there is a restriction, the total stocks.
amount of Retained Earnings may be
available for dividends. Appropriations covered by the board
- However there may instances and approved by the shareholders:
that a corporation may need is 1. Voluntary Appropriation
resources. To limit the - For contingencies
 CHAPTER 8
RETAIN EARNINGS
(ACCUMULATED PROFITS)
- For plant Expansion
2. Contractual Appropriation
- For Bonds or stocks issued
3. Legal Appropriation
- For treasury shares

Pro-forma Journal Entries:

Retained Earnings
Appropriated Retained Earnings

Appropriated Retained Earnings

Retained Earnings