LO10–5 Describe retained earnings and record cash dividends.

What is invested capital?

Capital provided by stockholders through buying stock (common, preferred, APIC).

What is earned capital?

Capital the company earns through operations (net income minus dividends), accumulated in retained earnings.

What are retained earnings?

All net income minus all dividends since the company began.

Formula for retained earnings

Retained Earnings = Total Net Income − Total Dividends (lifetime to date)

Does retained earnings represent cash?

No — retained earnings is not a cash account; it is an equity account.

What causes retained earnings to increase?

Net income.

What causes retained earnings to decrease?

Net losses and dividends.

What is an accumulated deficit?

A negative retained earnings balance caused by cumulative losses or dividends exceeding profits.

How does an accumulated deficit affect equity?

It reduces total stockholders’ equity because it is a negative retained earnings balance.

Example: Year 1 net loss of $1,000 — effect on retained earnings

Retained earnings becomes −$1,000 (accumulated deficit).

Example: Year 2 net income of $3,000 — cumulative retained earnings

−1,000 + 3,000 = 2,000 retained earnings.

Why do start‑ups often have negative retained earnings?

Early losses exceed early profits, creating an accumulated deficit.

Where is retained earnings reported?

In the stockholders’ equity section of the balance sheet.

What does retained earnings represent conceptually?

The portion of profits the company has kept rather than distributed as dividends.

Can retained earnings exceed paid‑in capital?

Yes — in mature, profitable companies, retained earnings often grow larger than invested capital.

What happens if dividends exceed profits over time?

Retained earnings becomes negative (accumulated deficit).

What is a cash dividend?

A distribution of a corporation’s earnings to its stockholders, usually paid in cash.

Why do investors care about dividends?

Dividend changes signal future prospects. Increases are often seen as good news about financial health.

Why do some profitable companies NOT pay dividends?

Growth companies reinvest earnings into expansion instead of distributing cash (e.g., Meta, Alphabet, Berkshire Hathaway).

When do companies usually start paying dividends?

When they mature and growth opportunities slow down (e.g., Microsoft, Apple).

What are the three important dividend dates?

Declaration date, record date, payment date.

What happens on the declaration date?

The board declares the dividend, creating a legal obligation.

This is the most important date

• The company becomes legally obligated to pay.

• A liability is created (Dividends Payable).

• Retained Earnings will eventually decrease (through the Dividends account).

Debit Dividends

Credit Dividends Payable

This is the ONLY date that reduces retained earnings (indirectly).

What happens on the record date?

This is simply the date the company checks its list of stockholders to see who gets the dividend.

• No journal entry

• No financial effect

• Purely administrative

You must own the stock on this date to receive the dividend.

What happens on the payment date?

This reduces:

• Cash

• The liability

But does NOT affect retained earnings (that already happened on declaration date).

Debit Dividends Payable

Credit Cash

Dividends are paid on what shares?

OUTSTANDING SHARES

• Issued shares include treasury stock

• Outstanding shares exclude treasury stock

Dividends are paid only on outstanding shares because treasury stock does not receive dividends.

What do issued shares include?

These are ALL shares the company has ever given out.

Issued shares include:

• Shares held by the public

• Shares held by insiders

• Treasury stock (shares the company bought back)

Issued = Outstanding + Treasury Stock

What do outstanding shares include?

These are the shares that are currently owned by stockholders.

Outstanding shares include:

• Shares held by the public

• Shares held by insiders

Outstanding shares exclude:

• Treasury stock (because the company owns these shares itself)

So:

Outstanding = Issued − Treasury Stock

Why dividends are paid ONLY on outstanding shares?

Dividends are payments to stockholders.

Treasury stock is not held by stockholders.
It is held by the company itself.

A company cannot pay a dividend to itself.

That would be like taking money out of your left pocket and putting it in your right pocket — nothing actually happened.

So:

• Issued shares include treasury stock → NOT all of these get dividends

• Outstanding shares exclude treasury stock → ONLY these get dividends

This is why dividends are calculated using outstanding shares.

Why is Dividends a temporary account?

It is closed into Retained Earnings at year‑end, reducing retained earnings.

Why is Dividends Payable a liability?

Once declared, the company is legally obligated to pay the dividend soon.

What is a property dividend?

A dividend paid in noncash assets (e.g., investment securities). Covered in intermediate accounting.

Net effect of declaring and paying cash dividends

Retained Earnings ↓ and Cash ↓.

Does declaring a dividend affect cash?

No — only the payment date reduces cash.

Does paying a dividend affect retained earnings?

No — retained earnings was reduced on the declaration date, not the payment date.