Slide

2-1

Chapter
INCOME AND CHANGES
12 IN RETAINED EARNINGS

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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2-2

Reporting
Reporting the
the Results
Results of
of Operations
Operations

Information
Information about
about net
net income
income can
can be
be divided
divided into
into
two
two major
major categories
categories

Normal,
Normal,recurring
recurringrevenue
revenueand
and Unusual,
Unusual,nonrecurring
nonrecurringevents
events
expense
expensetransactions.
transactions. that
thataffect
affectnet
netincome.
income.

Income
Incomefrom
from 1.1.The
Theresults
results 2.2.The
Theimpact
impact 3.
3.The
Theeffects
effects
continuing
continuing of of of
of of ofchanges
changesin in
operations.
operations. discontinued extraordinary accounting
discontinued extraordinary accounting
operations
operations items.
items. principles.
principles.

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This
Thistax
taxexpense
expense
does
doesnot
notinclude
include
effects
effects of
of unusual,
unusual,
nonrecurring
nonrecurringitems.
items.

These
Theseunusual,
unusual,
nonrecurring
nonrecurringitems
items
are
areeach
eachreported
reported
net
net of
oftaxes.
taxes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Discontinued
Discontinued Operations
Operations
When
When management
management enters
entersinto
intoaaformal
formalplan
planto
tosell
sell or
or
discontinue
discontinueaa segment
segmentofofthe
thebusiness,
business,the
therelated
related gains
gains
and
andlosses
lossesmust
must be
bedisclosed
disclosedononthe
theincome
incomestatement.
statement.

Income/Loss from
operating the segment
prior to disposal.
Discontinued
Operations

Income/Loss on disposal
of the segment.

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Discontinued
Discontinued Operations
Operations
When
When management
management enters
entersinto
intoaaformal
formalplan
planto
tosell
sell or
or
discontinue
discontinueaa segment
segmentofofthe
thebusiness,
business,the
therelated
related gains
gains
and
andlosses
lossesmust
must be
bedisclosed
disclosedononthe
theincome
incomestatement.
statement.

AAsegment
segment must
must bebe aaseparate
separateline
line
of
ofbusiness
businessactivity
activityor
oran
anoperation
operation
that
thatservices
servicesaadistinct
distinctcategory
categoryof
of
customers.
customers.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Discontinued
Discontinued Operations
Operations -- Example
Example

During
During 2003,
2003, Apex
Apex Co.Co. sold
sold an
an unprofitable
unprofitable
segment
segment of of the
the company.
company. The The segment
segment had had aa
net
net loss
loss from
from operations
operations during
during the
the period
period of of
$150,000
$150,000 and and its
its assets
assets sold
sold at
at aa loss
loss of of
$100,000.
$100,000. Apex Apex reported
reported income
income from from
continuing
continuing operations
operations of of $350,000.
$350,000. All All items
items
are
are taxed
taxed at
at 30%.
30%.
How
How will
will this
this appear
appear on
on the
the income
income
statement?
statement?
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Discontinued
Discontinued Operations
Operations -- Example
Example

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2-8

Discontinued
Discontinued Operations
Operations -- Example
Example

Income Statement Presentation:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Extraordinary
Extraordinary Items
Items

Material
 Material in
in amount.
amount.
Gains
 Gains or
or losses
losses that
that
are
are both
both unusual
unusual in in
nature
nature and
and not
not
expected
expected to to recur
recur in
in
the
the foreseeable
foreseeable future.
future.
Reported
 Reported netnet of
of
related
related taxes.
taxes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Extraordinary
Extraordinary Items
Items -- Example
Example

During
During 2003,
2003, Apex
Apex Co.Co. experienced
experienced aa loss
loss ofof
$75,000
$75,000 due
due to
to an
an earthquake
earthquake at at one
one ofof its
its
manufacturing
manufacturing plants
plants in
in Nashville.
Nashville. This
This was
was
considered
considered anan extraordinary
extraordinary item.
item. The
The
company
company reported
reported income
income before
before
extraordinary
extraordinary item
item of
of $175,000.
$175,000. AllAll gains
gains
and
and losses
losses are
are subject
subject to
to aa 30%
30% tax
tax rate.
rate.
How
How would
would this
this item
item appear
appear on
on the
the 2003
2003
income
income statement?
statement?
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Extraordinary
Extraordinary Items
Items -- Example
Example

Income Statement Presentation:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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2-12

Accounting
Accounting Changes
Changes

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Change
Change in
in Accounting
Accounting Principle
Principle

 Occurs
Occurs when
when changing
changing from
from
one
one GAAP
GAAP method
method to to another
another
GAAP
GAAP method.
method.
 Make
Make aa catch-up
catch-up adjustment
adjustment
known
known as as the
the cumulative
cumulative effect
effect
of
of aa change
change inin accounting
accounting
principle.
principle.
 The
The cumulative
cumulative effect
effect is
is
reported
reported net
net of
of taxes
taxes and
and after
after
extraordinary
extraordinary items.
items.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Change
Change in
in Accounting
Accounting Principle
Principle
Example
Example
Also
Also in
in 2003,
2003, Apex
Apex Co.
Co. decided
decided to to change
change fromfrom
the
the double-declining
double-declining balancebalance to to the
the straight-line
straight-line
method
method for for depreciation.
depreciation. The The effect
effect of
of this
this
change
change is is an
an increase
increase in in net
net income
income of of $65,000.
$65,000.
Apex
Apex reported
reported income
income before
before cumulative
cumulative effect
effect
of
of an
an accounting
accounting change
change of of $122,500
$122,500 during
during thethe
year.
year. All
All items
items of
of income
income areare subject
subject to to aa 30%
30%
tax
tax rate.
rate.
How
How would
would this
this item
item appear
appear on
on the
the income
income
statement?
statement?
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Change
Change in
in Accounting
Accounting Principle
Principle
Example
Example
Computation:

Income Statement Presentation:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Change
Change in
in Estimates
Estimates

 Revision
Revision of
of aa previous
previous
accounting
accounting estimate.
estimate.
 The
The new
new estimate
estimate should
should
be
be used
used in
in the
the current
current and
and
future
future periods.
periods.
 The
The prior
prior accounting
accounting
results
results should
should notnot be
be
disturbed.
disturbed.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Change
Change in
in Estimates
Estimates -- Example
Example

On
On January
January 1,
1, 2000,
2000, wewe purchased
purchased
equipment
equipment costing
costing $30,000,
$30,000, with
with aa useful
useful
life
life of
of 10
10 years
years and
and nono salvage
salvage value.
value.
During
During 2003,
2003, we
we determine
determine that
that the
the
remaining
remaining useful
useful is
is 55 years
years (8-year
(8-year total
total
life).
life). We
We use
use straight-line
straight-line depreciation.
depreciation.
Compute
Compute the the revised
revised depreciation
depreciation expense
expense
for
for 2003.
2003.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Change
Change in
in Estimates
Estimates -- Example
Example

Record depreciation expense of $4,200 for

2003 and subsequent years.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Let’s move
on to a few
final
topics.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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2-20

Price-earnings
Price-earnings Ratio
Ratio (P/E)
(P/E)

Often,
Often,the
thePrice-Earnings
Price-EarningsRatio
Ratiois
isused
usedto
toevaluate
evaluate
the
thereasonableness
reasonablenessofofaacompany’s
company’s stock
stockprice.
price.

Let’s
Let’sexamine
examinethis
this
further.
further.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Earnings
Earnings Per
Per Share
Share (EPS)
(EPS)

AAmeasure
measureof
ofthe
thecompany’s
company’sprofitability
profitabilityand
and
earning
earning power
power for
for the
theperiod.
period.

Based
Basedon onthe
thenumber
numberofofshares
shares
issued
issuedand
andthe
thelength
lengthof
oftime
time
that
thatnumber
numberremained
remained
unchanged.
unchanged.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Earnings
Earnings Per
Per Share
Share (EPS)
(EPS) --
Partial
Partial Income
Income Statement
Statement
Remember
Remember that that Apex
Apex Co.Co. income
income from
from
continuing
continuing operations
operations of of $350,000.
$350,000. The
The
after-tax
after-tax loss
loss from
from discontinued
discontinued operations
operations
was
was $175,000.
$175,000. TheThe extraordinary
extraordinary loss
loss was
was
$52,500
$52,500 and
and the
the cumulative
cumulative effect
effect of
of
accounting
accounting changes
changes waswas aa gain
gain of
of $45,500.
$45,500.
Assume
Assume that that Apex
Apex has
has weighted
weighted average
average
shares
shares outstanding
outstanding of of 156,250.
156,250. Prepare
Prepare aa
partial
partial income
income statement
statement showing
showing thethe EPS
EPS
for
for Income
Income from
from Operations
Operations and and for
for the
the
other
other special
special items.
items.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Earnings
Earnings Per
Per Share
Share (EPS)
(EPS) --
Partial
Partial Income
Income Statement
Statement

* Rounded.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Earnings
Earnings Per
Per Share
Share (EPS)
(EPS)

IfIfpreferred
preferredstock
stockisispresent,
present, subtract
subtract preferred
preferred
dividends
dividendsfromfromnet
netincome
incomeprior
priorto
tocomputing
computingEPS.
EPS.

EPS is required to be reported

in the income statement.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Accounting
Accounting for
for Cash
Cash Dividends
Dividends

Declared
Declared by
by board
board Not
Not legally
legally
of
of directors.
directors. required.
required.

Requires
Requires sufficient
sufficient
Creates
Creates liability
liability Retained
Retained Earnings
Earnings
at
at declaration.
declaration. and
and Cash.
Cash.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Dividend
Dividend Dates
Dates

Date
Date of
of Declaration
Declaration
 Board of directors declares the dividend.
Board of directors declares the dividend.
 Record a liability.
Record a liability.

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Dividend
Dividend Dates
Dates

Ex-Dividend
Ex-Dividend Date
Date
 The day which serves as the ownership cut-off
The day which serves as the ownership cut-off
point
pointfor
forthe
thereceipt
receiptof
ofthe
themost
mostrecently
recently
declared
declareddividend.
dividend.

NO ENTRY

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Dividend
Dividend Dates
Dates

Date
Date of
of Record
Record
 Stockholders holding shares on this date
Stockholders holding shares on this date
will
will receive
receive the
the dividend.
dividend. (No
(No entry)
entry)

X
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Dividend
Dividend Dates
Dates

Date
Date of
of Payment
Payment
 Record the payment of the dividend to
Record the payment of the dividend to
stockholders.
stockholders.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Dividend
Dividend Dates
Dates -- Question
Question

On
On June
June 1,
1, 2003,
2003, aa corporation’s
corporation’s boardboard of
of
directors
directors declared
declared aa dividend
dividend forfor the
the 2,500
2,500 shares
shares
of
of its
its $100
$100 par
par value,
value, 8%8% preferred
preferred stock.
stock. The
The
dividend
dividend will
will be
be paid
paid on
on July
July 15.15. Which
Which ofof the
the
following
following will
will be
be included
included in
in the
the July
July 15
15 entry?
entry?
$100 × 8% = $8 dividend per share
$100 × 8% = $8 dividend per share

a. Debit $8
$8 ×× 2,500
Retained2,500 ==$20,000
$20,000
Earnings total
total dividend
dividend
$20,000.
a. Debit Retained Earnings $20,000.
b.
b. Debit
Debit Dividends
Dividends Payable
Payable $20,000.
$20,000.
c.
c. Credit
Credit Dividends
Dividends Payable
Payable $20,000.
$20,000.
d.
d. Credit
Credit Preferred
Preferred Stock
Stock $20,000.
$20,000.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
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Accounting
Accounting for
for Stock
Stock Dividends
Dividends

Distribution
Distribution of
of additional
additional shares
shares of
of stock
stock to
to
stockholders.
stockholders.

No
Nochange
changein
intotal
total No
Nochange
changeininpar
par
stockholders’
stockholders’ equity.
equity. values.
values.

All
Allstockholders
stockholders
retain
retainsame
same
percentage
percentage
ownership.
ownership.
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Summary
Summary of
of Effects
Effects of
of Stock
Stock
Dividends
Dividends and
and Stock
Stock Splits
Splits
Small
SmallStock
Stock Large
Large Stock
Stock Stock
StockSplits
Splits
Dividend
Dividend Dividend
Dividend
Total
Total
Stockholders'
Stockholders' No
NoEffect
Effect No
NoEffect
Effect No
NoEffect
Effect
Equity
Equity
Common
CommonStock
Stock Increases
Increases Increases
Increases No
NoEffect
Effect
Paid-in
Paid-inCapital
Capital Increases
Increases No
NoEffect
Effect No
NoEffect
Effect
Retained
RetainedEarnings
Earnings Decreases
Decreases Decreases
Decreases No
NoEffect
Effect
Number
Numberof ofShares
Shares Increases
Increases Increases
Increases Increases
Increases
Outstanding
Outstanding
Par
ParValue
Valueper
per No
NoEffect
Effect No
NoEffect
Effect Decreases
Decreases
Share
Share

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Prior
Prior Period
Period Adjustments
Adjustments
The
The correction
correction ofof an
an error
error identified
identified as
as
affecting
affecting net
net income
income inin aa prior
prior period.
period.

Adjust
Adjustretained
retained The
The adjustment
adjustment
earnings
earnings retroactively.
retroactively. should
shouldbebedisclosed
disclosed
net
netof
ofany
anytaxes.
taxes.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

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Comprehensive
Comprehensive Income
Income

Normally,
Normally, there
there are
are 33 ways
ways that
that financial
financial
position
position can
can change.
change.

Issuance
Issuanceof
ofnew
new Net
NetIncome
Incomeoror Payment
Paymentofof
shares
sharesof
ofstock.
stock. Net
NetLoss
Loss Dividends
Dividends

GAAP
GAAPexcludes
excludessome
someunrealized
unrealized items
itemsfrom
from
income,
income, such
such as
asthe
the change
change in
inmarket
market value
valueof
of
available-for-sale
available-for-saledebt
debtand
andequity
equity investments.
investments.

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Comprehensive
Comprehensive Income
Income
GAAP
GAAPrequires
requiresthat
thatunrealized
unrealizeditems
itemsthat
thatare
arenormally
normallyreported
reported
on
onthe
thebalance
balancesheet
sheetbe
beadded
addedback
backtotocompute
compute
“Comprehensive
“ComprehensiveIncome.”
Income.”

The
Theaccumulated
accumulatedamount
amountof
of There
Thereare
are33options
optionsfor
for
changes
changesaffecting
affecting reporting
reportingComprehensive
Comprehensive
Comprehensive
ComprehensiveIncome
Incomeis
is Income.
Income.
reported
reportedin
inequity.
equity.

As
Asaasecond
second Combined
Combinedwith
with As
Asananelement
elementof
of
Income
Incomestatement.
statement. Net
NetIncome
Incomeon
onthe
the Stockholders’
Stockholders’
Income
Income Equity.
Equity.
Statement.
Statement.
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2-36

Hang in there!
We’re coming down
the home stretch!
Yeah, that’s
easy for you
to say!

End of
Chapter
12
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002