Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds

1
Fundamental Financial Accounting ConceptsFourth
EditionbyEdmonds, McNair, Milam, Olds

• PowerPoint presentation by
• J. Lawrence Bergin

2
Chapter 11

• Accounting
• for
• Equity Transactions

3
Characteristics of Different Forms of Business
Organization

• Issues in deciding between sole
  proprietorship, partnership, or corporation
• Personal liability
• Taxation
• Transfer of ownership
• Ability to raise capital
• Government regulation

4
Equity in Proprietorships

• Contributed capital and retained earnings are
  combined into a single capital account
• John Doe, Capital XXXX
• Distributions are called withdrawals. As
  withdrawals increase, equity decreases.
• John Doe, Withdrawals XXXX

5
Equity in Partnerships

• Each partner has her/his own separate capital
  account, each containing the partners invested
  capital and share of retained earnings.
• As with proprietorships, partnerships use
  withdrawal accounts for the distributions made to
  the owners. Each partner has his/her own
  withdrawal (or Drawing) account.

6
Corporations

• A corporation is a popular form of business
  because . . .
• It is simple for individuals to purchase small
  amounts of stock.
• It allows for an easy transfer of ownership
  through established markets, like the New York
  Stock Exchange.
• It provides stockholders with limited liability.

7
Corporations

• Because a corporation is a separate legal entity,
  it can . . .
• Own assets.
• Incur liabilities.
• Sue and be sued.
• Enter into contracts independent of the
  stockholder owners.
• Many Americans own stock through a mutual fund or
  pension program.

8
Ownership of a Corporation

• Owners of common stock generally receive the
  following rights
• Voting (in person or by proxy).
• Distributions of profits (in the form of
  Dividends).
• Distributions of assets in a liquidation.
• Offers to purchase shares of a new stock issue
  (pro rata basis).

9
Creating a Corporation

• State laws govern the creation of corporations.
• An application for a charter (or articles of
  incorporation) must include the corporations
  name and purpose, kinds and amounts of capital
  stock authorized, and other detailed information.
  

10
Creating a Corporation

• Once the state issues a charter, the
  stockholders elect a board of directors.

11
Authorized, Issued, and Outstanding Capital Stock
Authorized Shares
The maximum number of shares of capital stock
that can be sold to the public is called the
authorized number of shares.
12
Authorized, Issued, and Outstanding Capital Stock
Authorized Shares
Issued shares have been sold.
Unissued shares have never been sold.
13
Authorized, Issued, and Outstanding Capital Stock
Authorized Shares
owned by stockholders.
Outstanding Shares
Unissued Shares
Issued Shares
14
Authorized, Issued, and Outstanding Capital Stock
Authorized Shares
owned by stockholders.
Outstanding Shares
Unissued Shares
Issued Shares
Treasury Shares
reacquired by the corporation.
15
Sale and Issuance of Capital Stock

• An initial public offering (IPO) is the very
  first time a corporation sells stock to the
  public.

16
Common Stock

• Basic voting stock of the corporation
• Ranks after preferred stock for dividend and
  liquidation distribution.
• Dividend rates are determined by the board of
  directors based on the corporations
  profitability and other factors.

17
Par Value and No-par Value Stock

• Par value
• Is a nominal value per share of capital stock
  specified in the charter.
• Has no relationship to market value.
• Serves as the basis for legal capital.
• Legal capital is the amount of capital, required
  by the state, that must remain invested in the
  business.
• It serves as a cushion for creditors.

18
Par Value and No-par Value Stock

• No-par value is capital stock that does not have
  an amount per share specified in the charter.
• When no-par stock is issued by a corporation, the
  amount of legal capital is defined by the state.
• Stated value is an amount per share that is
  specified by the corporation when it issues
  no-par stock.

19
Preferred Stock

• Has dividend and liquidation preference over
  common stock.
• Cumulative preferred stock has a preference for
  all past dividends over any paid to common
  shareholders.
• Generally does not have voting rights.
• Usually has a par or stated value.
• Usually has a fixed dividend rate that is stated
  as a percentage of the par value.

20
Special Features of Preferred Stock

• Convertible preferred stock may be exchanged for
  common stock. (Its up to the stockholder to
  decide.)

• Callable preferred stock may be
• purchased by the corporation at a
• predetermined price.
  
• (Its the companys choice.)

21
Accounting for Capital Stock Transactions

• Two primary sources of stockholders equity
• Contributed capital
• Par or stated value of issued stock.
• Additional paid-in capital in excess of par or
  stated value.
• Retained earnings
• The cumulative net income earned by the
  corporation less the cumulative dividends
  declared by the corporation.

22
Accounting for the Issue of Common Stock

• When stock is issued, the equity account Common
  Stock is credited (increased) for the par or
  stated value of the stock.
• If the stock sold for more than par, the
  additional amount is credited (increased) to the
  equity account Paid in Capital in Excess of Par,
  Common Stock.

23
Record these transactions using the Horizontal
model then state their effects
1. ABC Co. issued 21 shares of 10 par common
stock for 12 each. 2. ABC Co. issued 10
shares of 100 par, 6 cumulative preferred stock
for 110 per share. 3. ABC Co. bought back 2
shares of its 10 par common stock at a cost of
11 per share. 4. ABC Co. reissued 1 share of
its 11 Treasury Stock for 13. 5. On 12/7 ABC
declared dividends totaling 200. Last year
preferred dividends were not paid. (Assume
sufficient R.E. exists.) 6. On 12/30, paid the
dividends to stockholders of record on 12/24. 7.
ABC declared and distributed a 10 stock
dividend on outstanding common stock. The market
value on the declaration date was 15 per share.
(Assume sufficient R/E exists.) 8. The Board
appropriated 20 of Ret. Earnings for future
plant expansion. 9. At year-end, the company
closed out the Dividends Declared account.
24
Accounting for Capital Stock Transactions
The following abbreviations are used in the
horizontal model.
D/P Dividends Payable P/S Preferred
Stock C/S Common Stock PICinX-PS Paid in
Capital in Excess of par, Pref. Stock PICinX-CS
Paid in Capital in Excess of par, Common
Stk. PICinTrStk Paid in Capital in Excess of
Cost from Treasury Stock
transactions Unapp R.Earn Unappropriated
Retained Earnings Approp R. Earn Appropriated
Retained Earnings Divid Decld (Cash) Dividends
Declared T.Stk or Treas. Treasury Stock
25
Complete the Horizontal Model Note
Last year the company issued ten 10 common
shares for 12 each and earned a 300 Net
Income.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/P D/PP/S
C/SPICin PIC PICinUnappApprop Divid.-
Treas. Pref Com par par X-PS
X-CS TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300
B1 2 3 4
5
6
7


8 9 B



26
Record the financial statement effect of each
transaction on this form.
Tran. Inc. Statemt St. of Ch. in
Stk. Eq. Cashflow 1. 2.
3. 4. 5.
6. 7. 8.
9.
27
Special Note regarding the Horizontal Model

• The horizontal model that follows only has a
  Balance Sheet section. Why?

• We needed to save space and,
• The Income Statement is NOT AFFECTED by any of
  the stock transactions described in this chapter.
• ALL stock and dividend transactions affecting
  cash will be Financing Activities on the
  cashflow statement.

28
1. ABC Co. issued 21 shares of 10 par common
stock for 12 per share.
AssetLiability
Stockholders Equity
Paid in Capital Retained
Earnings - T.Stk
CashD/PD/PP/SC/SPICinP
ICin PIC Unapp Approp - Divid.- Treas.
Pref Com par par X-PS X-CS TrStk
R.Earn R. Earn. Decld _at_ cost
B1
420 100
20 300
252 210
42

• Income Statement No effect.
• Statement of Changes in Equity Stk.Eq.
  (PIC) increases by a total of 252.
• Statemt of Cash Flows Fin. Activ. 252 cash
  inflow.

29
Accounting for the Issue of Preferred Stock

• When stock is issued, the equity account
  Preferred Stock is credited (increased) for the
  par or stated value of the stock.
• If the stock sold for more than par, the
  additional amount is credited (increased) to the
  equity account Paid in Capital in Excess of Par,
  Preferred Stock.

30
2. ABC Co. issued 10 shares of 100 par, 6
cumulative preferred stock for 110 per share.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings - T.Stk
CashD/PD/PP/SC/S
PICinPICin PIC Unapp Approp - Divid.-
Treas. Pref Com par par X-PS X-CS
TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42
B 1 2
1100 1000 100

• Income Statement No effect.
• Statement of Changes in Stockholders Equity
  Stk.Eq. (PIC) increases by a total of 1,100.
• Statemt of Cash Flows Fin. Activ. 1100 inflow.

31
Treasury Stock

• A corporations own stock that had been issued
  but was subsequently reacquired and is still
  being held by that corporation.
• Why would a corporation reacquire its own stock?
• To reduce the shares outstanding.
• Because the market price is low.
• To increase earnings per share, if shares wont
  be reissued soon.
• To use in employee stock option programs.

32
Treasury Stock

• is considered issued stock but not outstanding
  stock.
• has no voting or dividend rights.
• is a contra equity account.
• reduces total stockholders equity on the Balance
  Sheet.

33
3. ABC Co. bought back 2 shares of its 10 par
common stock for 11 per share.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/PD/PP/SC
/SPICinPICin PIC Unapp Approp - Divid.-
Treas. Pref Com par par X-PS X-CS
TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100
B1 2 3
(22) 22

• Income Statement No effect.
• Statement of Changes in Stockholders Equity
  Stk.Eq. decreases because T.S. (contra Eq.)
  increases.
• Statemt of Cash Flows Financing Activ. 22
  outflow.

34
Treasury Stock Transactions

• Treasury stock is recorded at cost.
• The account, Treasury Stock, is contra to all of
  Equity and subtracted at the end of the Equity
  section on the Balance Sheet.
• If the treasury stock is subsequently resold for
  more than the cost, another equity account,
  PIC-Treasury Stock, would be credited (increased)
  for the excess over cost. If resold for less
  than cost, debit (decrease) PIC-Tr.Stk.
• NO gains or losses are recorded on the purchase
  or on the reissue of treasury stock.

35
4. ABC Co. reissued 1 share of its 11 Treasury
Stock for 13 per share.
AssetLiability
Stockholders Equity
Paid in Capital Retained
Earnings T.Stk
CashD/PD/PP/SC/SPICin
PICin PIC Unapp Approp - Divid.- Treas.
Pref Com par par X-PS X-CS TrStk
R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
B1 2 3
4 13
2 (11)

• Income Statement No effect.
• Statement of Changes in Stockholders Equity
  Stk.Eq. increases because T.S. (contra Eq.)
  decreases PIC incr.
• Statemt of Cash Flows Financing Activ. 13
  inflow.

36
Accounting for Cash Dividends

• Dividends must be declared by the board of
  directors before they can be paid.
• The corporation is not legally required to
  declare (and subsequently pay) dividends.
• Once a cash dividend is declared, a liability
  (Dividends Payable) is created.
• Cash dividends require sufficient cash and
  retained earnings, but NOT necessarily Net
  Income in the current year, to cover the
  dividend.

37
Dividend Dates

• Date of declaration
• Date of record
• Date of actual payment to shareholders

January
7 24
30
38
Dividends on Preferred Stock

• Current preferred dividends must be paid before
  paying any dividends to common stock.
• If a preferred dividend is not paid, the unpaid
  amount is either cumulative (a dividend in
  arrears) or noncumulative.
• Cumulative Unpaid dividends must be paid before
  common dividends.
• Noncumulative Unpaid dividends are lost.

39
Calculating Preferred and Common Dividends

• Remember ABC Co. has 10 shares of 100 par, 6
  cumulative preferred stock outstanding. Assume
  that NO dividends were paid in 2004.
• At the end of 2005, the Board of Directors
  declares a total of 200 worth of dividends for
  its preferred and common shareholders.
• How much will go to the preferred shareholders?

40
Preferred Shareholders get their dividends first

• Cumulative means that the preferred shareholders
  get all the past dividends that they were not
  paid (called dividends in arrears which must be
  footnoted, but NOT reported as a liability on the
  balance sheet) before common stockholders can
  receive a dividend.
• 10 preferred shares x 100 par x .06 60/year
• They get a total of 120 60 for 2004 dividends
  in arrears and 60 for 2005 current year
  dividend.
• Common shareholders get the remaining 80.
  (80/30 shares outstanding2.67 per share.)
  31 shares issued - 1 still in Treasury 30
  shares outstanding.

41
5. On 12/7 ABC declared dividends totaling 120
on Preferred and 80 on Common. (Assume
sufficient Unappropriated Ret. Earnings exist.)
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/PD/PP/SC
/SPICinPICin PIC Unapp Approp Divid.-
Treas. Pref Com par par X-PS X-CS
TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200

• Income Statement No effect.
• Statement of Changes in Stockholders Equity
  R. Earn. decreases because Div. (contra Eq.)
  increases.
• Statemt of Cash Flows No effect.

42
6. On 12/30 ABC Co. paid the dividends to the
stockholders of record on 12/24.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/PD/PP/SC
/SPICinPICin PIC Unapp Approp Divid.-
Treas. Pref Com par par X-PS X-CS
TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200
6 (200) (120) (80)

• Income Statement No effect.
• Statement of Changes in Stk. Equity No effect.
• Statemt of Cash Flows 200 Financing Act.
  outflow.

43
Journal entries

• Dividends 200
• Dividends Payable, Pref. 120
• Dividends Payable, Com. 80
• To record the declaration of cash dividends.
• What is the journal entry when the dividends are
  actually paid to the shareholders?
• Dividends Payable, Pref. 120
• Dividends Payable, Com. 80
• Cash 200

44
Cash Dividends

• Whats needed to pay cash dividends?
• retained earnings
• cash (but, could borrow cash to pay dividend)
• no restrictions from outsiders
• Effects of cash dividends on financial statements
• decreases Assets (when they are actually paid)
  and Retained Earnings (dividends).
• NO EFFECT on Net Income.

45
Accounting for Stock Dividends

• Stock dividends are distributions to stockholders
  of additional shares of stock, NOT CASH!
• Why issue a stock dividend?
• Low on cash (but want to reward stockholders)
  
• To decrease market price of stock. Why?
• To increase number of stockholders (assuming
  some of the newly issued stock will be sold).

46
Accounting for Stock Dividends

• All stockholders receive the same percentage
  increase in the number of shares they own (pro
  rata basis).
• No change in total stockholders equity.
• No change in par values.
• Affect on financial statements?

47
7. ABC declared a 10 stock dividend on Com.
Stk. 30 outstanding 10 par shares, 15 market
value each.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/P D/PP/S
C/SPICin PIC PICinUnappApprop Divid.-
Treas. Pref Com par par X-PS
X-CS TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200
6 (200) (120) (80)
7

• Income Statement
• Statement of Changes in Stockholders Equity
• Statement of Cash Flows

48
Valuing the Stock Dividend

• How many new shares are issued?
• Stock Dividend X shares outstanding
• X shares
• new shares
• Value of the STOCK dividend?
• of new shares X Market value on date
• of declaration
• shares X
• in total

49
Valuing the Stock Dividend

• How many new shares are issued?
• Stock Dividend X shares outstanding
• 10 X 30 shares
• 3 new shares
• Value of the STOCK dividend?
• of new shares X Market value on date
• of declaration
• 3 shares X 15
• 45 in total

50
Valuing the Stock Dividend

• How is the 45 allocated to the stock accounts?
• Value of Stock dividend
• Less 10 par value of 3 new shares
• Paid in Capital in excess of par-C.S.
  

Question What if the Common Stock was
no par stock?
51
Valuing the Stock Dividend

• How is the 45 allocated to the stock accounts?
• Value of Stock dividend 45
• Less 10 par value of 3 new shares 30
• Paid in Capital in excess of par-C.S. 15
  

Question What if the Common Stock was
no par stock? Then all 45 would go into the
Common Stock - No par account.
52
7. ABC declared a 10 stock dividend on Com.
Stk. 30 outstanding 10 par shares, 15 market
value each.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/P D/PP/S
C/SPICin PIC PICinUnappApprop Divid.-
Treas. Pref Com par par X-PS
X-CS TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200
6 (200) (120) (80)
7 30
15 (45)

• Income Statement No effect.
• State. of Ch. in Eq No effect on total Eq, but
  less R.E, more PIC.
• Statemt of Cash Flows NO EFFECT! (Not a CASH
  div.)

53
Retained Earnings

• Appropriating (or Restricting) Retained Earnings
• Board of Directors can restrict (imposed by
  outsiders) or appropriate (companys choice)
  portions of retained earnings.
• It is a way of communicating why more dividends
  are not being paid.
• Does NOT change TOTAL Ret. Earnings.
  
• An appropriation (or restriction) only
  separates the retained earnings into two
  categories, unappropriated and appropriated.
  (Must have Unappropriated or Unrestricted R.E. to
  declare dividends.)

54
8. Board appropriated 20 of Retained Earn.
for future plant expansion.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/P D/PP/S
C/SPICin PIC PICinUnappApprop Divid.-
Treas. Pref Com par par X-PS
X-CS TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200
6 (200) (120) (80)
7 30
15 (45)


(20) 20

8

• Income Statement No effect.
• State. of Ch. in Eq No change in TOTAL Ret.
  Earn. or Equity.
• Statemt of Cash Flows No effect.

55
9. At year-end, the company closed out the
Dividends Declared account.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/P D/PP/S
C/SPICin PIC PICinUnappApprop Divid.-
Treas. Pref Com par par X-PS
X-CS TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200
6 (200) (120) (80)
7 30
15 (45)


(20) 20

8 9 B

(200)
(200)
56
What is the financial statement effect of each
transaction
Tran. Inc. Statemt St. of Ch. in
Stk. Eq. Cashflow 1. No effect Paid
in Cap. Increased Inflow F.A. 2. No
effect Paid in Cap. Increased Inflow
F.A. 3. No effect Stk. Eq.
Decreased Outflow F.A. 4. No
effect Stk. Eq. Inc, b-cuz TS dec. Inflow F.A. 5.
No effect R.E dec. b-cuz Div.
Increase No effect 6. No effect
No effect (asset Liab. dec.) Outflow F.A. 7.
No effect No effect on TOTAL Stk.Eq.
NO effect (but less R.E. and more PIC)
(stock given, not cash.) 8.
No effect No effect, Total Ret. E. same
No effect 9. No effect No effect,
Total RE same No effect (close of Div. offset
by RE decr.)
57
Calculate final balances for the Stockholders
Equity section of the year-end Balance Sheet.
AssetLiability
Stockholders Equity
Paid in Capital
Retained Earnings T.Stk
CashD/P D/PP/S
C/SPICin PIC PICinUnappApprop Divid.-
Treas. Pref Com par par X-PS
X-CS TrStk R.Earn R. Earn. Decld _at_ cost
420 100
20 300 252
210 42 1100
1000 100 (22) 22
13
2
(11)
B1 2 3 4
5 120 80

200
6 (200) (120) (80)
7 30
15 (45)


(20) 20

8 9 B

(200)
(200)
1563 0 0 1000 340 100 77
2 35 20 0
11
Stockholders Equity section of Balance Sheet
on next slide.
58
Stockholders Eq. section of ABCs Balance Sheet
Stockholders Equity Preferred Stock, 100
par, 6 cumulative, xxx shares authorized, 10
shares issued outstandg Common
Stock, 10 par, yyy shares authorized, 31
shares issued, 30 shares outstanding
Paid-in-Capital in Excess of Par-Preferred
Paid-in-Capital in Excess of Par-Common
Paid-in-Capital in Excess of
Cost-Treasury Stock Total
Paid-in-Capital 1,519 Retained Earnings
Appropriated Unappropriated
Total Retained Earnings
Total Less Treasury Stock, 1 share
at cost Total Stockholders Equity
1,563
59
Stockholders Eq. section of ABCs Balance Sheet
Stockholders Equity Preferred Stock, 100
par, 6 cumulative, xxx shares authorized, 10
shares issued outstandg 1,000
Common Stock, 10 par, yyy shares authorized,
31 shares issued, 30 shares outstanding
340 Paid-in-Capital in Excess of
Par-Preferred 100 Paid-in-Capital in
Excess of Par-Common 77
Paid-in-Capital in Excess of Cost-Treasury Stock
2 Total Paid-in-Capital
1,519 Retained Earnings Appropriated
20 Unappropriated 35 Total
Retained Earnings 55 Total
1,574 Less Treasury Stock, 1 share at
cost (11) Total Stockholders Equity
1,563
60
Accounting for Stock Splits

• Distributions of 100 or more of stock to
  stockholders.
• Decreases par value per share of stock, but total
  par value stays the same.
• Increases number of outstanding shares.
• No change in total stockholders equity.
• Does not require a journal entry.

61
Stock Split example

• XYZ Co. has 1000 shares outstanding. Each
  share has a 10 par value, but is selling on the
  NYSE for 80 per share.
• The Company declares a 4 for 1 stock split.
• Complete the following
• Before After
• shares outstanding
• Par value per share
• Total par value
• Total stock market value
• Market value per share

1,000 10 10,000 80,000
80
4,000 2.50 10,000 80,000 20
62
Stock Split example

• XYZ Co. has 1000 shares outstanding. Each
  share has a 10 par value, but is selling on the
  NYSE for 80 per share.
• The Company declares a 4 for 1 stock split.
• Complete the following
• Before After
• shares outstanding
• Par value per share
• Total par value
• Total stock market value
• Market value per share

63
Stock Split example continued

• XYZ Co. has 1000 shares outstanding. Each
  share has a 10 par value, but is selling on the
  NYSE for 80 per share.
• The Company declares a 4 for 1 stock split.
• Ms. Smith owned 100 shares before the split.
• Complete the following for Ms. Smiths stock
• Before After
• shares owned...
• Total company shares...
• of stock owned...
• Total market value of
• Ms. Smiths stock.

100 1,000 10 8,000
400 4,000 10 8,000

Remember, the stock price dropped from 80 to 20
per share.
64
Stock Split example continued

• XYZ Co. has 1000 shares outstanding. Each
  share has a 10 par value, but is selling on the
  NYSE for 80 per share.
• The Company declares a 4 for 1 stock split.
• Ms. Smith owned 100 shares before the split.
• Complete the following for Ms. Smiths stock
• Before After
• shares owned...
• Total company shares...
• of stock owned...
• Total market value of
• Ms. Smiths stock.

Remember, the stock price dropped from 80 to 20
per share.
65
Retained Earnings

• Represents the net income (loss) that has been
  earned less dividends that have been declared
  since the first day of operations for the company.

Example (amounts assumed)
Balance January 1, 2004 500,000 Net
income for 2004 30,000 - Dividends
for 2004 Cash dividends (10,000)
Stock dividends ( 5,000) Balance
January 31, 2004 515,000
66
Retained Earnings

• What affects Retained Earnings?
• net income (or loss) through closing entries
• cash dividends
• stock dividends
• prior period adjustments
• Accounting ERRORS made in previous years that are
  being corrected now.

67
Price-Earnings Ratio

• Selling price of one share of stock
• Earnings per share
• This ratio is used by analysts to evaluate the
  future prospects of a company.
• The higher the PE ratio, the more optimistic
  investors are about a companys future.
• Earnings per share (net income - preferred
  dividends) divided by the weighted average number
  of common shares of outstanding stock. Why is
  the weighted average number of shares used?

68
Chapter 11
The End