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Chapter 12. INCOME AND CHANGES IN RETAINED EARNINGS. Normal, recurring revenue and expense transactions. Unusual, nonrecurring events that affect net income. 1. Results of discontinued operations. 2. Impact of extraordinary items. 3. Effects of changes in accounting principles. - PowerPoint PPT Presentation
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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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INCOME AND CHANGES IN RETAINED EARNINGS
Chapter
12
© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
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Information about net income can be divided Information about net income can be divided into two major categoriesinto two major categories
Information about net income can be divided Information about net income can be divided into two major categoriesinto two major categories
Income from continuing operations.
Income from continuing operations.
1. Results of discontinued operations.
1. Results of discontinued operations.
2. Impact of extraordinary
items.
2. Impact of extraordinary
items.
3. Effects of changes in accounting principles.
3. Effects of changes in accounting principles.
Normal, recurring revenue and expense transactions.
Normal, recurring revenue and expense transactions.
Unusual, nonrecurring events that affect net income.
Unusual, nonrecurring events that affect net income.
Reporting the Results of OperationsReporting the Results of Operations
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This tax expense does not include
effects of unusual, nonrecurring items.
This tax expense does not include
effects of unusual, nonrecurring items.
These unusual, nonrecurring items are each reported
net of taxes.
These unusual, nonrecurring items are each reported
net of taxes.
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Discontinued Operations: When a company has a discontinued operation, it must report the income or loss from operating a segment that has been discontinued, and the gain or loss on the sale of the segment net of taxes.
Extraordinary items are gains and losses that are both unusual and infrequent in occurrence. Some examples include losses from natural disasters and expropriation of property by a foreign government. Extraordinary items are also reported net of taxes.
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During 2007, Matrix, Inc. sold an unprofitable During 2007, Matrix, Inc. sold an unprofitable segment of the company. The segment had a segment of the company. The segment had a net loss from operations during the period of net loss from operations during the period of $150,000 and a loss on the sale of its assets $150,000 and a loss on the sale of its assets
of $100,000. Matrix reported income from of $100,000. Matrix reported income from continuing operations of $1,750,000. All continuing operations of $1,750,000. All
items are taxed at 30%. items are taxed at 30%.
How will this appear on the income How will this appear on the income statement?statement?
During 2007, Matrix, Inc. sold an unprofitable During 2007, Matrix, Inc. sold an unprofitable segment of the company. The segment had a segment of the company. The segment had a net loss from operations during the period of net loss from operations during the period of $150,000 and a loss on the sale of its assets $150,000 and a loss on the sale of its assets
of $100,000. Matrix reported income from of $100,000. Matrix reported income from continuing operations of $1,750,000. All continuing operations of $1,750,000. All
items are taxed at 30%. items are taxed at 30%.
How will this appear on the income How will this appear on the income statement?statement?
Discontinued OperationsDiscontinued Operations
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Discontinued OperationsDiscontinued Operations
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Income Statement Presentation:
Discontinued OperationsDiscontinued Operations
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During 2007, Matrix, Inc. experienced a loss of During 2007, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its $75,000 due to an earthquake at one of its
manufacturing plants in Nashville. This was manufacturing plants in Nashville. This was considered an extraordinary item. The considered an extraordinary item. The
company reported income before extraordinary company reported income before extraordinary item of $1,575,000. All gains and losses are item of $1,575,000. All gains and losses are
subject to a 30% tax rate.subject to a 30% tax rate.
How would this item appear on the 2007 How would this item appear on the 2007 income statement?income statement?
During 2007, Matrix, Inc. experienced a loss of During 2007, Matrix, Inc. experienced a loss of $75,000 due to an earthquake at one of its $75,000 due to an earthquake at one of its
manufacturing plants in Nashville. This was manufacturing plants in Nashville. This was considered an extraordinary item. The considered an extraordinary item. The
company reported income before extraordinary company reported income before extraordinary item of $1,575,000. All gains and losses are item of $1,575,000. All gains and losses are
subject to a 30% tax rate.subject to a 30% tax rate.
How would this item appear on the 2007 How would this item appear on the 2007 income statement?income statement?
Extraordinary ItemsExtraordinary Items
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Income Statement Presentation:
Extraordinary Items - ExampleExtraordinary Items - Example
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A measure of the company’s profitability and earning power for the period.
A measure of the company’s profitability and earning power for the period.
Based on the number of shares issued and the length of time
that number remained unchanged.
Based on the number of shares issued and the length of time
that number remained unchanged.
Earnings Per Share (EPS)Earnings Per Share (EPS)
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Remember that Matrix, Inc. has income from Remember that Matrix, Inc. has income from continuing operations of $1,750,000. The after-continuing operations of $1,750,000. The after-
tax loss from discontinued operations was tax loss from discontinued operations was $175,000 and the extraordinary loss was $175,000 and the extraordinary loss was
$52,500. Assume that Matrix has 156,250 $52,500. Assume that Matrix has 156,250 weighted average shares outstanding.weighted average shares outstanding.
Prepare a partial income statement showing the Prepare a partial income statement showing the EPS for income from continuing operations and EPS for income from continuing operations and
for the other special items. for the other special items.
Remember that Matrix, Inc. has income from Remember that Matrix, Inc. has income from continuing operations of $1,750,000. The after-continuing operations of $1,750,000. The after-
tax loss from discontinued operations was tax loss from discontinued operations was $175,000 and the extraordinary loss was $175,000 and the extraordinary loss was
$52,500. Assume that Matrix has 156,250 $52,500. Assume that Matrix has 156,250 weighted average shares outstanding.weighted average shares outstanding.
Prepare a partial income statement showing the Prepare a partial income statement showing the EPS for income from continuing operations and EPS for income from continuing operations and
for the other special items. for the other special items.
Earnings Per Share (EPS)Earnings Per Share (EPS)
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* Rounded.
Earnings Per Share (EPS)Earnings Per Share (EPS)
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If preferred stock is present, subtract preferred dividends from net income prior to computing EPS.
If preferred stock is present, subtract preferred dividends from net income prior to computing EPS.
EPS is required to be reported in the income statement.
EPS is required to be reported in the income statement.
Earnings Per Share (EPS)Earnings Per Share (EPS)
Net Income - Preferred DividendsWeighted Average Number of Common Shares Outstanding
Earnings Per Share
=
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Basic and Diluted Earnings per ShareBasic and Diluted Earnings per Share
If a company has convertible securities, If a company has convertible securities, like convertible preferred stock like convertible preferred stock
outstanding, the conversion of these outstanding, the conversion of these securities to common stock may dilute securities to common stock may dilute
(reduce) earnings per share.(reduce) earnings per share.
If a company has convertible securities, If a company has convertible securities, like convertible preferred stock like convertible preferred stock
outstanding, the conversion of these outstanding, the conversion of these securities to common stock may dilute securities to common stock may dilute
(reduce) earnings per share.(reduce) earnings per share.
Diluted earnings per share reflect the Diluted earnings per share reflect the impact of the assumed conversion of impact of the assumed conversion of
the securities on earnings.the securities on earnings.
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Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price.
Often, the Price-Earnings Ratio is used to evaluate the reasonableness of a company’s stock price.
Price-earnings Ratio (P/E)Price-earnings Ratio (P/E)
Let’s examine this further.
Let’s examine this further.
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Declared by Board of Directors.
Declared by Board of Directors.
Not legally required.
Not legally required.
Creates liability at declaration.
Creates liability at declaration.
Requires sufficient Retained Earnings
and Cash.
Requires sufficient Retained Earnings
and Cash.
Accounting for Cash DividendsAccounting for Cash Dividends
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Date of Declaration• Board of Directors declares the dividend.• Record a liability.
Date of Declaration• Board of Directors declares the dividend.• Record a liability.
Dividend DatesDividend Dates
On March 1, 2007, the Board of Directors of Matrix, Inc. declares a $1.00 per share cash dividend on its 500,000 common shares outstanding. The dividend is payable to
stockholders of record on April 1, and paid on May 1.
On March 1, 2007, the Board of Directors of Matrix, Inc. declares a $1.00 per share cash dividend on its 500,000 common shares outstanding. The dividend is payable to
stockholders of record on April 1, and paid on May 1.
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Ex-Dividend Date• The day which serves as the ownership
cut-off point for the receipt of the most recently declared dividend.
Ex-Dividend Date• The day which serves as the ownership
cut-off point for the receipt of the most recently declared dividend.
NO ENTRY
Dividend DatesDividend Dates
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Date of Record• Stockholders holding shares on this date will
receive the dividend. (No entry)
Date of Record• Stockholders holding shares on this date will
receive the dividend. (No entry)
Dividend DatesDividend Dates
XApril 2007
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Date of Payment• Record the payment of the dividend to
stockholders.
Date of Payment• Record the payment of the dividend to
stockholders.
Dividend DatesDividend Dates
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All stockholders retain same percentage ownership.
All stockholders retain same percentage ownership.
No change in total stockholders’ equity.No change in total
stockholders’ equity.No change in par
values.No change in par
values.
Accounting for Stock DividendsAccounting for Stock Dividends
Distribution of additional shares of stock to stockholders.
Distribution of additional shares of stock to stockholders.
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Small Stock Dividend
Large Stock Dividend
Stock Splits
Total Stockholders'
EquityNo Effect No Effect No Effect
Common Stock Increases Increases No EffectPaid-in Capital Increases No Effect No Effect
Retained Earnings Decreases Decreases No Effect
Number of Shares Outstanding
Increases Increases Increases
Par Value per Share
No Effect No Effect Decreases
Small Stock Dividend
Large Stock Dividend
Stock Splits
Total Stockholders'
EquityNo Effect No Effect No Effect
Common Stock Increases Increases No EffectPaid-in Capital Increases No Effect No Effect
Retained Earnings Decreases Decreases No Effect
Number of Shares Outstanding
Increases Increases Increases
Par Value per Share
No Effect No Effect Decreases
Summary of Effects of Stock Dividends and Stock Splits
Summary of Effects of Stock Dividends and Stock Splits
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Adjust retained earnings retroactively.
Adjust retained earnings retroactively.
The adjustment should be disclosed
net of any taxes.
The adjustment should be disclosed
net of any taxes.
The correction of an error identified as affecting net income in a prior period.
The correction of an error identified as affecting net income in a prior period.
Prior Period AdjustmentsPrior Period Adjustments
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Statement of Retained Earnings with Prior Period Adjustment
Statement of Retained Earnings with Prior Period Adjustment
