Accounting for Corporations: Dividends, Retained Earnings, and Income Reporting

Accounting for Dividends and Stock Splits

Learning Objectives

LO 1:

Explain how to account for cash dividends, stock dividends, and stock splits.

LO 2:

Discuss how stockholders’ equity is reported and analyzed.

LO 3:

Describe the form and content of corporation income statements.

Cash Dividends

Requirements for Cash Dividend Payment

A corporation must fulfill the following criteria to pay cash dividends:

1. Retained Earnings: Payment of cash dividends from retained earnings is permissible in all states.
2. Adequate Cash: Sufficient cash resources must be available to make payments.
3. Board of Directors Declaration: The Board of Directors must declare the dividend.

Key Dividend Dates

1. Declaration Date: The date the Board of Directors announces the dividend.
2. Record Date: The date on which the company determines who is eligible to receive the dividend.
3. Payment Date: The date the dividend is paid to stockholders.

Example of Cash Dividends

Illustration: On December 1, 2022, Media General declared a cash dividend of 50 cents per share on 100,000 shares.

• Entry on Declaration:
  Dec. 1
  $\text{Cash Dividends} \text{ } 50,000$
  $\text{Dividends Payable} \text{ } 50,000$

• Payment Entry (on January 20):
  $\text{Dividends Payable} \text{ } 50,000$
  $\text{Cash} \text{ } 50,000$

Dividend Preferences for Preferred Stockholders

1. Priority: Preferred stockholders have the right to receive dividends before common stockholders.
2. Cumulative Dividends: If dividends are not paid in previous years, preferred stockholders must receive both current and past due amounts before common stockholders.

Example of Cumulative Dividends

Illustration: For 5,000 shares of 7% cumulative preferred stock with a par value of $100:

• Annual Dividend:
  $5,000 \times 7 \text{ (or } 0.07) = 35,000$
• If there are 2 years in arrears, total payments will be:
  $35,000 \times 2 + 35,000 = 105,000$

Allocating Cash Dividends

Dividends must first cover unpaid prior-year amounts for preferred stock before any amount is allocated to common stock.

Stock Dividends

Definition and Purpose

A stock dividend represents a proportional distribution of additional shares to stockholders.

Reasons for Stock Dividends:

1. To avoid cash payment for dividends.
2. To increase the marketability of stock.
3. To indicate that part of stockholders' equity is reinvested in the business.

Classification of Stock Dividends

1. Small Stock Dividend: Less than 20-25% of the outstanding shares, recorded at fair market value.
2. Large Stock Dividend: Greater than 20-25%, recorded at par value.

Journal Entry Example for Stock Dividends

Illustration: Medland Corporation declares a 10% stock dividend:

• Fair market value: $15, par value: $10
• Entry on Declaration Date:
  $\text{Stock Dividends} \text{ } 75,000$
  $\text{Common Stock Dividends Distributable} \text{ } 50,000$
  $\text{Paid-in Capital in Excess of Par—Common Stock} \text{ } 25,000$

Effects of Stock Dividends on Financial Statements

Stock dividends do not affect total stockholders' equity; they just reallocate it between retained earnings and paid-in capital.