Chapter Four

Accounting for
Corporations
 4.1. The Corporate Form of Organization
What is Corporation?
 Many years ago, a noted scholar defined a corporation
as “an artificial being, invisible, intangible, and existing
only in contemplation of law.”
 This definition is the foundation for the prevailing legal
interpretation in many countries that:
 A corporation is an entity separate and distinct from
its owners.
 A corporation is created by law, and its continued
existence depends upon the statutes of the jurisdiction
in which it is incorporated.
 Cont’d
 As a legal entity, a corporation has most of the
rights and privileges of a person.
 The major exceptions relate to privileges that only
a living person can exercise, such as the right to
vote or to hold public office.
 A corporation is subject to the same duties and
responsibilities as a person. For example, it must
abide by the laws, and it must pay taxes.
 Two common ways to classify corporations are by
purpose and by ownership.
 Cont’d
Classified by Purpose Classified by Ownership
 Not-for-Profit  Publicly held
 For Profit  Privately held

► Salvation Army
(USA)
► Toyota (JPN) ► Cargill Inc.
► International
► Siemens (DEU) (USA)
Committee of the
Red Cross (CHE) ► Sinopec (CHN)
► GE (USA)
Characteristics of a Corporation
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
 Transferable Ownership Rights
Advantages
 Ability to Acquire Capital
 Continuous Life
 Corporate Management
 Government Regulations
Disadvantages
 Additional Taxes
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
Corporation acts under its
 Separate Legal Existence own name rather than in
the name of its
 Limited Liability of Shareholders shareholders.
 Transferable Ownership Rights
 Ability to Acquire Capital
 Continuous Life
 Corporate Management
 Government Regulations
 Additional Taxes
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
Limited to their
 Limited Liability of investment.
Shareholders
 Transferable Ownership Rights
 Ability to Acquire Capital
 Continuous Life
 Corporate Management
 Government Regulations
 Additional Taxes
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
 Transferable Ownership Rights Shareholders may
sell their shares.
 Ability to Acquire Capital
 Continuous Life
 Corporate Management
 Government Regulations
 Additional Taxes
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
Corporation can
 Transferable Ownership Rights obtain capital
 Ability to Acquire Capital through the issuance
of shares.
 Continuous Life
 Corporate Management
 Government Regulations
 Additional Taxes
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
 Transferable Ownership Rights
 Ability to Acquire Capital
 Continuous Life Continuance as a going
concern is not affected
 Corporate Management by the withdrawal,
 Government Regulations death, or incapacity of
a shareholder,
 Additional Taxes
employee, or officer.
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
 Transferable Ownership Rights
 Ability to Acquire Capital
 Continuous Life
Separation of ownership
 Corporate Management
and management prevents
 Government Regulations owners from having an
active role in managing the
 Additional Taxes
company.
 Cont’d
Illustration 11-1
Corporation Organization Chart Shareholders

Chairman &
Board of
Directors

President and
CEO

General Vice President

Vice President Vice President Vice President
Counsel and Human
Marketing Finance/CFO Operations
Secretary Resources

Treasurer Controller
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
 Transferable Ownership Rights
 Ability to Acquire Capital
 Continuous Life
Government
 Corporate Management regulations are
 Government Regulations designed to protect
 Additional Taxes the owners of the
corporation.
 Cont’d
Characteristics that distinguish corporations from
proprietorships and partnerships.
 Separate Legal Existence
 Limited Liability of Shareholders
 Transferable Ownership Rights
 Ability to Acquire Capital Corporations pay
 Continuous Life income taxes as a
separate legal entity
 Corporate Management and in addition,
 Government Regulations shareholders pay
taxes on cash
 Additional Taxes
dividends.
 Cont’d
Illustration 11-2
Advantages and Disadvantages
of a Corporation
Forming a Corporation
Initial Steps:
 File application with governmental agency in the
jurisdiction in which incorporation is desired.
 Government grants charter.
 Corporation develops by-laws.

Companies incorporate in a state or country whose

laws are favorable to the corporate form of business.
Corporations expense organization costs as incurred.
Ownership Rights to Shareholders
Shareholders have the right to:

1. Vote in election of board of

directors and on actions that
require shareholder approval.

2. Share the corporate earnings

through receipt of dividends.

Illustration 11-3
Ownership Rights of Shareholders
 Cont’d
Shareholders have the right to:
3. Keep the same percentage ownership when new shares
are issued (preemptive right*).
Illustration 11-3 : Ownership
Rights of Shareholders

* A number of companies have eliminated the preemptive right.

 Cont’d
Shareholders have the right to:
4. Share in assets upon liquidation in proportion to their
holdings. This is called a residual claim.

Illustration 11-3
Ownership Rights of Shareholders
 Cont’d
Illustration 11-4 : A share certificate Prenumbered

PAR VALUE PAR VALUE

$1 PER SHARE $1 PER SHARE

Name of corporation
Shareholder’s name
Shares
Bill Harmon

Signature of corporate
official
Share Issue Considerations
 In considering the issuance of shares, a corporation
must resolve a number of basic questions:
1) How many shares should it authorize for sale?
2) How should it issue the shares?
3) At what price should it issue the shares?
4) What value should the corporation assign to the
shares?
 Cont’d
AUTHORIZED SHARES
 Charter indicates the amount of shares that a
corporation is authorized to sell.
 Number of authorized shares is often reported
in the equity section.
 Cont’d
ISSUANCE OF SHARES
 Corporation can issue ordinary shares directly to
investors or indirectly through an investment banking
firm.
 Factors in setting price for a new issue of shares:
1. Company’s anticipated future earnings.
2. Expected dividend rate per share.
3. Current financial position.
4. Current state of the economy.
5. Current state of the securities market.
 Cont’d
MARKET PRICE SHARES
 Shares of publicly held companies is traded on
organized exchanges.
 Interaction between buyers and sellers
determines the prices per share.
 Prices tend to follow the trend of a company’s
earnings and dividends.
 Factors beyond a company’s control may cause
day-to-day fluctuations in market prices.
Investor Insight How to Read Share Quotes
Organized exchanges trade the shares of publicly held companies at prices
per share established by the interaction between buyers and sellers. For each
listed security, the financial press reports the high and low prices of the shares
during the year, the total volume of shares traded on a given day, the high and
low prices for the day, and the closing market price, with the net change for the
day. adidas (DEU) is listed on a number of exchanges. Here is a listing for
adidas (prices are in euros).

These numbers indicate the following. The high and low market prices for the
previous 52 weeks were €57.62 and €42.41. The trading volume for the day
was 1,080,000 shares. The high, low, and closing prices for that date were
€52.50, €50.77, and €50.79, respectively. The net change for the day was a
decrease of €1.081 per share.
 Cont’d
PAR AND NO-PAR VALUE SHARES

 Years ago, par value determined the legal capital

per share that a company must retain in the business
for the protection of corporate creditors.
 Today many governments do not require a par value.
 No-par value shares are fairly common today.
 In many countries the board of directors assigns a
stated value to no-par shares.
 Cont’d
Question # 1:

Which of the following statements is false?

a. Ownership of ordinary shares gives the owner a
voting right.
b. The equity section begins with a share capital section.
c. The authorization of share capital does not result in
a formal accounting entry.
d. Par value and market price of a company’s shares are
always the same.
 > DO IT!
Indicate whether each of the following statements is True
or False.
1. Similar to partners in a partnership, shareholders of a
corporation have unlimited liability.
2. It is relatively easy for a corporation to obtain capital
through the issuance of shares.
3. The separation of ownership and management is an
advantage of the corporate form of business.
4. The journal entry to record the authorization of
ordinary shares includes a credit to the appropriate
share capital account.
Corporate Capital
Equity is identified by various names:
 Stockholders’ equity,
 Shareholders’ equity, or
 Corporate capital.

The equity section of a corporation’s Statement of

Financial Position/SoFP consists of two parts:
1. Share capital and
2. Retained earnings (earned capital).
 Cont’d
 The distinction between share capital and retained
earnings is important from both a legal and a
financial point of view.
 Legally, corporations can make distributions of
earnings (declare dividends) out of retained earnings
in most countries.
 However, they often cannot declare dividends out of
share capital.
 Management, shareholders, and others often look to
retained earnings for the continued existence and
growth of the corporation.
 Cont’d
SHARE CAPITAL
 Share capital is cash and other assets paid in to the
corporation by shareholders in exchange for ordinary
shares.
 As noted earlier, when a corporation has only one class of
shares, they are ordinary shares.

RETAINED EARNINGS
 Retained earnings is net income that a corporation retains
for future use.
 Net income is recorded in RE’s by a closing entry that
debits Income Summary and credits RE’s.
 Cont’d
 For example, assuming that net income for Delta
Robotics in its first year of operations is
HK$1,300,000, the closing entry is:
 Cont’d
Illustration 11-5 : Equity Section
 Cont’d
Comparison of the equity accounts for a proprietorship, and
a corporation.

Illustration 11-6 :
Comparison of Equity Accounts
 > DO IT!

At the end of its first year of operation, Doral Corporation has

€750,000 of ordinary share and net income of €122,000. Prepare
(a) the closing entry for net income and (b) the equity section at
year-end.

(a) Income Summary 122,000

Retained Earnings 122,000

(b) Equity
Share capital—ordinary €750,000
Retained earnings 122,000
Total equity €872,000
 4.2. Accounting for Share Transactions
Accounting for Ordinary Share Issues
ISSUING PAR VALUE ORDINARY SHARES FOR CASH
 As discussed earlier, par value does not indicate a share’s
market price.
 Therefore, the cash proceeds from issuing par value shares
may be equal to, greater than, or less than par value.
 When the company records issuance of ordinary shares for
cash, it credits to Share Capital—Ordinary the par value of
the shares.
 It records in a separate account the portion of the proceeds
that is above or below par value.
 Cont’d
Illustration: Hydro Slide, Inc. issues 1,000 shares
of €1 par value ordinary shares. Prepare Hydro-Slide’s
journal entry if (a) 1,000 shares are issued for €1 per
share, and (b) 1,000 shares are issued for €5 per
share.
a) Cash 1,000
Share Capital—Ordinary (1,000 x €1) 1,000

b) Cash 5,000

Share Capital—Ordinary (1,000 x €1) 1,000

Share Premium—Ordinary 4,000
 Cont’d
 The total capital from these two transactions is €6,000,
and the legal capital is €2,000. Assuming Hydro-Slide,
Inc. has retained earnings of €27,000, Illustration
below shows the company’s equity section.
Illustration 11-57: Share Premium
 Cont’d
 When a corporation issues shares for less than par
value, it debits the account Share Premium—Ordinary
if a credit balance exists in this account.
 If a credit balance does not exist, then the
corporation debits to Retained Earnings the amount
less than par.
 This situation occurs only rarely: Most jurisdictions
do not permit the sale of ordinary shares below par
value because shareholders may be held personally
liable for the difference between the price paid upon
original sale and par value.
 Cont’d
ISSUING NO-PAR VALUE ORDINARY SHARES FOR CASH

 When no-par ordinary shares have a stated value, the

entries are similar to those illustrated for par value
shares.
 The corporation credits the stated value to Share
Capital—Ordinary.
 Also, when the selling price of no-par shares exceeds
stated value, the corporation credits the excess to
Share Premium—Ordinary.
 Cont’d
Illustration: Assume that instead of €1 per shares, Hydro-
Slide, Inc. has €5 stated value no-par shares and the company
issues 5000 shares at €8 per share for cash. The entry is:
Cash 40,000
Share Capital—Ordinary (5,000 x €5) 25,000
Share Premium—Ordinary 15,000
Hydro-Slide, Inc. reports Share Premium—Ordinary below Share Capital
— Ordinary in the equity section.

Prepare the entry assuming there is no stated value.

Cash 40,000
Share Capital—Ordinary 40,000
 Cont’d
ISSUING ORDINARY SHARES FOR SERVICES OR NON-CASH ASSETS

 Corporations also may issue shares for Services

(compensation to attorneys or consultants) or non-cash
assets (land, buildings, and equipment).
 In such cases, what cost should be recognized in the
exchange transaction?
 To comply with the historical cost principle, in a non-
cash transaction cost is the cash equivalent price.

Cost is either the fair market value of the consideration given up,
or the fair market value of the consideration received, whichever
is more clearly determinable.
 Cont’d
Illustration: Assume that attorneys have helped Jordan
Company incorporate. They have billed the company €5,000
for their services. They agree to accept 4,000 shares of €1
par value shares in payment of their bill. At the time of the
exchange, there is no established market price for the
shares. Prepare the journal entry for this transaction.

Organization Expense 5,000

Share Capital—Ordinary 4,000
Share Premium—Ordinary 1,000
 Cont’d
Illustration: Assume that Athletic Research Inc. is an
existing publicly held corporation. Its €5 par value shares
are actively traded at €8 per share. The company issues
10,000 shares to acquire land recently advertised for sale
at €90,000. Prepare the journal entry for this
transaction.
Land 80,000
Share Capital—Ordinary 50,000
Share Premium—Ordinary 30,000

As illustrated in these examples, the par value of the shares is never a

factor in determining the cost of the assets received. This is also
true of the stated value of no-par shares.
 > DO IT!
Hefei Ltd. begins operations on March 1 by issuing 1,000,000
¥10 par value ordinary shares for cash at ¥12 per share. On
March 15, it issues 50,000 ordinary shares to attorneys in
settlement of their bill of ¥600,000 for organization costs.
Journalize the issuance of the shares, assuming the shares
are not publicly traded.
Mar. 1 Cash 12,000,000
Share Capital—Ordinary 10,000,000
Share Premium—Ordinary 2,000,000

Mar. 15 Organization Expense 600,000

Share Capital—Ordinary 500,000
Share Premium—Ordinary 100,000
Accounting for Treasury Shares
Treasury shares are a corporation’s own shares that it
has reacquired from shareholders but not retired.
Corporations purchase their outstanding shares to:
1. Reissue the shares to officers and employees under
bonus and share compensation plans.
2. Enhance the share’s market value.
3. Have additional shares available for use in the
acquisition of other companies.
4. Increase earnings per share.
5. Eliminate hostile shareholders by buying them out.
 Cont’d
PURCHASE OF TREASURY SHARES
 Companies generally account for treasury shares by the
cost method.
 This method uses the cost of the shares purchased to
value the treasury shares.
 Under the cost method, the company debits Treasury
Shares for the price paid to reacquire the shares.
 When the company disposes of the shares, it credits
to Treasury Shares the same amount it paid to
reacquire the shares.
 Cont’d
 To illustrate, assume that on January 1, 2014, the equity
section of Mead, Inc. has 100,000 HK$50 par value
ordinary shares outstanding (all issued at par value) and
Retained Earnings of HK$2,000,000. The equity section
before purchase of treasury shares is as follows.

Illustration 11-8: Equity Section With No Treasury Shares

 Cont’d
Illustration: On February 1, 2017, Mead acquires 4,000
shares of its stock at HK$80 per share.
Treasury Shares (4,000 x HK$80) 320,000

Cash 320,000
 Note that Mead debits Treasury Shares for the cost of the
shares purchased.
 Is the original Share Capital—Ordinary account affected? No,
because the number of issued shares does not change.
 In the equity section of the SoFP, Mead deducts treasury
shares after retained earnings to determine total equity.
 Treasury Shares is a contra-equity account. Thus, the
acquisition of treasury shares reduces equity.
 Cont’d
The equity section of Mead, Inc. after purchase of treasury
shares is as follows.
Illustration 11-9 : Equity Section With Treasury Shares

Both the # of shares issued (100,000), outstanding (96,000), and the #

of shares held as treasury (4,000) are disclosed.
 Cont’d
Question # 2:
In the statement of financial position, the cost of
treasury shares is deducted in:
a. expenses.
b. revenues.
c. equity.
d. liabilities.
 Cont’d
DISPOSAL OF TREASURY SHARES
Sale of Treasury Shares
 Above Cost
 Below Cost

Both increase total assets and equity.

 Cont’d
Sale of Treasury Securities Above Cost
Illustration: On July 1, Mead sells for HK$100 per
share 1,000 shares of its treasury shares, previously
acquired at HK$80 per share.

July 1 Cash 100,000

Treasury Shares (1,000 x HK$80) 80,000
Share Premium—Treasury 20,000

A corporation does not realize a gain or suffer a loss from share

transactions with its own shareholders.
 Cont’d
Sale of Treasury Securities Below Cost
Illustration: On Oct. 1, Mead sells an additional 800
treasury shares at HK$70 per share.
Oct. 1 Cash 56,000
Share Premium—Treasury 8,000
Treasury Shares (800 x HK$80) 64,000

Illustration 11-10 : Treasury Share Accounts

 Cont’d
When a company fully depletes the credit balance in Share
Premium—Treasury, it debits to Retained Earnings any
additional excess of cost over selling price.

Illustration: On Dec. 1, assume that Mead, Inc. sells its

remaining 2,200 shares at HK$70 per share.

Dec. 1 Cash 154,000

Limited to
Share Premium—Treasury 12,000 balance
on hand
Retained Earnings 10,000
Treasury Shares 176,000
 > DO IT!
Salvador Inc. purchases 3,000 shares of its R$50 par
value ordinary shares for R$180,000 cash on July 1. It
will hold the shares in the treasury until resold. On
November 1, the corporation sells 1,000 treasury shares
for cash at R$70 per share. Journalize the treasury
share transactions.

July 1 Treasury Shares 180,000

Cash 180,000

Nov. 1 Cash 70,000

Treasury Shares 60,000
Share Premium—Treasury 10,000
Accounting for Preference Shares
 To appeal to more investors, a corporation may issue an
additional class of shares, called preference shares.
 They have contractual provisions that give them some
preference or priority over ordinary shares.
 Typically, preference shareholders have a priority as to
1) distributions of earnings (dividends) and
2) assets in the event of liquidation.
 However, they sometimes do not have voting rights.

Accounting for preference shares at issuance is similar to that for

ordinary shares.
 Cont’d
Illustration: Stine Corporation issues 10,000 shares of
€10 par value preference shares for €12 cash per share.
Journalize the issuance of the preference shares.

Cash 120,000
Share Capital—Preference (10,000 x €10) 100,000
Share Premium—Preference 20,000

Preference shares may have a par value or no-par value.

Dividend Preferences
 Preference shareholders have the right to receive
dividends before ordinary shareholders.
 If the dividend rate on preference shares is €5 per share,
ordinary SH’s will not receive any dividends in the current
year until preference SH’s have received €5 per share.
 The first claim to dividends does not, however, guarantee
the payment of dividends.
 Dividends depend on many factors, such as adequate
retained earnings and availability of cash.
 If a company does not pay dividends to preference SH’s, it
cannot of course pay dividends to ordinary shareholders.
Cumulative Dividend
 Preference shares often contain a cumulative dividend feature.
 Preference SH’s must be paid both current-year dividends & any
unpaid prior-year dividends before ordinary SH’s receive.
 When preference shares are cumulative, preference dividends
not declared in a given period are called dividends in arrears.
 Are dividends in arrears considered a liability? No—no payment
obligation exists until the board of directors declares a
dividend.
 However, companies should disclose in the notes to the
financial statements the amount of dividends in arrears.
 Doing so enables investors to assess the potential impact of this
commitment on the corporation’s financial position.
 Cont’d
Illustration: Scientific Leasing has 5,000 shares of 7%,
€100 par value, cumulative preference shares outstanding.
Each €100 share pays a €7 dividend (.07 x €100). The annual
dividend is €35,000 (5,000 x €7 per share). If dividends are
two years in arrears, preference shareholders are entitled to
receive the following dividends in the current year.

Illustration 11-11 : Computation of Total Dividends to Preference Shares

Liquidation Preferences
 Most preference shares have a preference on
corporate assets if the corporation fails.
 Provides security for the preference shareholder.
 Preference to assets may be for the par value of
the shares or for a specified liquidating value.
 4.3. Dividends
 A dividend is a corporation’s distribution of cash or
shares to its shareholders on a pro rata (proportional to
ownership) basis.
 Pro rata means that if you own 10% of the ordinary
shares, you will receive 10% of the dividend.
 Dividends can take four forms: cash, property, scrip (a
promissory note to pay cash), or shares.
 Cash dividends predominate in practice. Also, companies
declare share dividends with some frequency.
 Dividends expressed: (1) as a percentage of the par or
stated value, or (2) as a dollar amount per share.
Cash Dividends

Three dates: Illustration 11-12

Key dividend dates
 Cont’d
For a corporation to pay a cash dividend, it must have:

1. Retained earnings - Payment of cash dividends from

retained earnings is legal in all jurisdictions.

2. Adequate cash.

3. A declaration of dividends by the Board of Directors.

 Cont’d
Illustration: On Dec. 1, the directors of Media General
declare a €0.50 per share cash dividend on 100,000 shares
of €10 par value ordinary shares. The dividend is payable on
Jan. 20 to shareholders of record on Dec. 22.
December 1 (Declaration Date)
Cash Dividends 50,000
Dividends Payable 50,000

December 22 (Date of Record) No entry

January 20 (Payment Date)

Dividends Payable 50,000
Cash 50,000
 Cont’d
ALLOCATING CASH DIVIDENDS BETWEEN
PREFERENCE AND ORDINARY SHARES

Holders of cumulative preference shares must be

paid any unpaid prior-year dividends before ordinary
shareholders receive dividends.
 Cont’d
Illustration: On December 31, 2014, IBR Inc. has 1,000
shares of 8%, €100 par value cumulative preference shares.
It also has 50,000 shares of €10 par value ordinary shares
outstanding. At December 31, 2014, the directors declare
a €6,000 cash dividend. Prepare the entry to record the
declaration of the dividend.

Cash Dividends 6,000

Dividends Payable 6,000

Preference Dividends: 1,000 shares x €100 par x 8% = €8,000

 Cont’d
Illustration: At December 31, 2015, IBR declares a
€50,000 cash dividend. The allocation of the dividend
to the two classes of shares is as follows:

Illustration 11-13
Allocating dividends to preference and ordinary shares
 Cont’d
Illustration: At December 31, 2015, IBR declares a
€50,000 cash dividend. Prepare the entry to record
the declaration of the dividend.

Cash Dividends 50,000

Dividends Payable 50,000

Share Dividends
Pro rata distribution of the corporation’s own shares.

Illustration 11-14
Effect of stock split
for shareholders

Results in decrease in retained earnings and increase share capital

and share premium.
 Cont’d
Reasons why corporations issue share dividends:

1. Satisfy shareholders’ dividend expectations without

spending cash.

2. Increase marketability of the corporation’s shares.

3. Emphasize a portion of equity has been permanently

reinvested in the business.
 Cont’d
 Small share dividend (less than 20–25% of the
corporation’s issued shares, recorded at fair
market value) *
 Large share dividend (greater than 20–25% of
issued shares, recorded at par value)

* Accounting based on the assumption that a small share dividend

will have little effect on the market price of the outstanding shares.
 Cont’d
Illustration: Medland Cor. has a balance of NT$3,000,000 in
retained earnings. It declares a 10% share dividend on its
50,000 shares of NT$100 par value ordinary shares. The
current fair market value of its shares is NT$150 per share.

10% share dividend is declared

Share Dividends (50,000 x 10% x NT$150) 750,000
Ordinary Share Dividends Distributable 500,000
Share Premium—Ordinary 250,000

Shares issued
Ordinary Share Dividends Distributable 500,000
Share Capital—Ordinary (50,000 x 10% x NT$100) 500,000
 Cont’d
Statement Presentation

Illustration 11-15
Statement presentation of ordinary shares dividends distributable
 Cont’d
EFFECTS OF SHARE DIVIDENDS

Illustration 11-16
Share dividend effects
 Cont’d
Question # 3:
Which of the following statements about small share
dividends is true?
a. A debit to Retained Earnings for the par value of
the shares issued should be made.
b. A small share dividend decreases total equity.
c. Market price per share should be assigned to the
dividend shares.
d. A small share dividend ordinarily will have an
effect on par value per share.
Share Splits
 Reduces the market value of shares.
 No entry recorded for a share split.
 Decrease par value and increase number of
shares.
 Cont’d
Illustration: Assume Medland Corporation splits
its 50,000 ordinary shares on a 2-for-1 basis.

Illustration 11-17
Share split effects

Results in a reduction of the par or stated value per

share.
Investor Insight
A No-Split Philosophy
Warren Buffett’s company, Berkshire Hathaway (USA), has two classes
of shares. Until recently, the company had never split either class of
shares. As a result, the class A shares had a market price of $97,000 and
the class B sold for about $3,200 per share. Because the price per share
is so high, the shares do not trade as frequently as the shares of other
companies. Mr. Buffett has always opposed share splits because he feels
that a lower share price attracts short-term investors. He appears to be
correct. For example, while more than 6 million shares of IBM (USA) are
exchanged on the average day, only about 1,000 class A shares of
Berkshire are traded. Despite Mr. Buffett’s aversion to splits, in order to
accomplish a recent acquisition, Berkshire decided to split its class B
shares 50 to 1.
Source: Scott Patterson, “Berkshire Nears Smaller Baby B’s,” Wall Street Journal
Online (January 19, 2010).
 > DO IT!
The market price of Sing CD Company’s 500,000 shares of £2
par value ordinary shares is £45. President Joan Elbert is
considering either a 10% share dividend or a 2-for-1 share split.
She asks you to show the before-and-after effects of each
option on retained earnings, total equity, total shares
outstanding, and par value per share.

Share dividend amount is £2,250,000 [(500,000 × 10%) × £45].

4.4. Retained Earnings
 Net income increases Retained Earnings and a net loss
decreases Retained Earnings.

 Part of the shareholders’ claim on the total assets of the

corporation.

 Debit balance in Retained Earnings is identified as a

deficit.

Illustration 11-20
Equity with deficit
 Cont’d
Restrictions can result from:
1. Legal restrictions.
2. Contractual restrictions.
3. Voluntary restrictions.

Companies generally disclose retained earnings restrictions in the

notes to the financial statements.
Prior Period Adjustments
 Correction of an error in previously issued financial
statements.
 Result from:
► mathematical mistakes.
► mistakes in application of accounting principles.
► oversight or misuse of facts.
 Adjustment made to the beginning balance of retained
earnings.
 Cont’d
Debits and Credits to Retained Earnings

Illustration 11-23
Debits and credits to retained earnings
 > DO IT!
Chen Cor. has retained earnings of ¥5,130,000 on January 1,
2014. During the year, Chen earned ¥2,000,000 of net
income. It declared and paid a ¥250,000 cash dividend. In
2014, Chen recorded an adjustment of ¥180,000 due to the
understatement (from a mathematical error) of 2013
depreciation expense. Prepare a corrected retained earnings
statement for 2014.
Chen Corporation
Retained Earnings Statement
For the Year Ended December 31, 2014

Balance, January 1 ¥5,130,000

Add: Net income 2,000,000
Less: Dividends 250,000
Balance, December 31 ¥6,880,000
 > DO IT!
In 2014, Chen recorded an adjustment of ¥180,000 due to
the understatement (from a mathematical error) of 2013
depreciation expense. Prepare a retained earnings statement
for 2014.
Chen Corporation
Retained Earnings Statement
For the Year Ended December 31, 2014

Balance, January 1 ¥5,130,000

Correction for overstatemet of net income in
prior period (depreciation error) -180,000
Balance, January 1, as adjusted 4,950,000
Add: Net income 2,000,000
Less: Dividends 250,000
Balance, December 31 ¥6,700,000
 Cont’d
Question # 4:
All but one of the following is reported in a retained
earnings statement. The exception is:
a. cash and share dividends.
b. net income and net loss.
c. sales revenue.
d. prior period adjustments.
The End of Chapter 4
Thank You!!!