“Put most simply, kindness is ones willingness to become involved in another’s need.

-Kubel Shelly
2.6 Retained Earnings “I choose to do small acts of kindness.”

Retained earnings are the profits a corporation has earned since its organization, minus any
losses, dividends declared, or transfers to contributed capital. Generally speaking, retained
earnings is increased on an on-going basis by net income and decreased by net losses and
regular dividends, though other items can also affect the balance from time to time. It represents
the undistributed earnings of the company since its inception.

 A credit balance in Retained Earnings is normal, indicating that the corporation’s

lifetime earnings exceed its lifetime losses and dividends.
 A debit balance in Retained Earnings arises when a corporation’s lifetime losses and
dividends exceed its lifetime earnings. Called a deficit, this amount is subtracted from
the sum of the other equity accounts to determine total shareholders’ equity.
“We all make mistakes. We all have weaknesses. The Bible
says that we are not to have a hard-headed, critical spirit
2.6.1 Classification of Retained Earnings toward each other, but instead to forgive one another and to
A. Free or Unappropriated Retained Earnings show mercy to one another just as God for Christ’s sake has
done for us.”-Joyce Meyer
B. Appropriated Retained Earnings “I choose to avoid holding personal grudges.”

 In some cases restrictions to protect creditors are imposed that make a portion of the
current Retained Earnings balance unavailable for dividends.
 Restrictions are disclosed in the notes accompanying financial statements and result
from one or more of the following causes:
 Legal Regulatory agencies limit dividend payments to the balance of
Retained earnings.
 Contractual Debt covenants related to bank loans may restrict dividends to
a specified percent of retained earnings.
 Voluntary Corporate directors may limit dividends so that cash can be
used in the business to take advantage of investment
opportunities.
 When there is an appropriation of retained earnings, it is separately reported in the
financial statements and disclosed to inform users of special activities that require
funds.

“There is a positive side to every situation if we simply make the choice to find it.”-Judy M. Garty
“I choose to develop a positive outlook in life and demonstrate through my actions that I have faith in God.”
2.6.2 Dividends

Most publicly held firms distribute a portion of the assets generated by earnings as a dividend to
shareholders. A dividend is a corporation’s return to its shareholders of some of the benefits of
earnings, commonly in the form of cash payments. Thus, dividends are distributions of retained
earnings to shareholders in proportion to the number of shares held by owners.

The Corporation Code of the Philippines provides:

“No corporation shall make or declare dividend except from the
unrestricted retained earnings arising from its business or distribute
its capital stock or property other than actual profit among its
members or shareholders until after the payment of its debts and the
termination of its existence by limitation or lawful dissolution”

Accounting tells a company if it has the ability to pay cash dividends. To do so, a company must
have
 sufficient retained earnings to declare the dividend

1
  sufficient enough Cash to pay the dividend

Dividends are never required, but once declared become a legal liability of the corporation.

With the exception of treasury shares, all issued and fully paid shares, and all subscribed par
value shares are entitled to dividends when declared. Unissued shares, subscribed no-par shares
and treasury shares are not entitled to dividends.

A. Recognition and payment of dividends

Three dates are essential in the recognition and payment of dividends:

(1) Date of declaration.
 On the date of declaration, the board of directors will adopt a resolution
declaring that a dividend is to be paid. The resolution will specify the amount,
type, and date of payment of this dividend.
 Reduce the retained earnings and record liability for dividend.

(1) Date of record.

 A list of shareholders entitled to the declared dividends is prepared at the
end of record. On this date, ownership of shares determines who receives
the dividend.
 No entry is required.

(2) Date of payment.

 The corporation settles its liability on this date.
 Journal entry is required on this date to record payment of cash, property
or stock to shareholders.

 Classification of Dividends out of Earnings

(1) Cash Dividends
Corporations generally declare and pay cash dividends on shares outstanding when
three conditions exist:
 Sufficient retained earnings
 Sufficient cash
 Formal action by the board of directors
Cash dividends involve a reduction in retained earnings and in cash. It may be
expressed as a certain amount of pesos per share, or a certain percent of the par or
stated value.

To illustrate, assume that San Miguel Corporation declared a cash dividend of P12 per
share of ordinary shares on July 1. The dividends are payable on August 1 to
shareholders of record on July 21. The company has 10,000 ordinary shares issued of
which 700 shares are held in treasury. The entries to record the dividend declaration
and payment are as follows:

Retained Earnings 111,600

Cash Dividends Payable 111,600*

*P12 per share (10,000 issued shares – 700 treasury shares)= P111,600

The account, cash dividends declared, may be used in place of the debit to Retained
Earnings. At the end of the accounting period, this temporary shareholders’ equity
account will be closed by debiting Retained Earnings and crediting cash dividends
declared.

2
 Cash dividends payable 111,600
Cash 111,600
To record payment of dividend.

Cash dividends payable are reported as current liabilities in the statement of financial
position.

(2) Share dividends (Bonus Issue)

A share dividend is a proportional distribution by a corporation of its own stock to its

shareholders. This type of dividend affects only the accounts within the shareholders’
equity. Share dividends increase the shares account and decrease Retained
Earnings. Total equity is unchanged, and no asset or liability is affected.

For example, P&G Corporation distributes stock dividends to shareholders in

proportion to the number of shares they already own. If you own 300 ordinary shares
of P&G Corporation and P&G distributes a 10% ordinary share dividend, you will
receive 30 (300 x 0.10) additional shares. You would then own 330 ordinary shares. All
other P&G shareholders would also receive additional shares equal to 10% of their
prior holdings.

A share dividend is the distribution of additional shares of stock to current

shareholders of the corporation without receiving any payment in return.

 Total SHE is unchanged – A transfer is made from Retained Earnings to

Contributed Capital.
 Total outstanding shares will increase.
 Because each shareholder receives the same percentage increase in shares,
shareholders' proportional interest in (percentage ownership of) the firm remains
unchanged.

Share Dividends Distributable account are credited in the initial declaration entry,
to be removed in recording the increase to the ordinary share account once the shares
are actually issued.

 Presented as part of the paid-in capital in the shareholders’ equity.

 If a statement of financial position is prepared between the declaration date and the
distribution date of a share dividend, the Share Distributable account will be shown
in the shareholders’ equity immediately after the Share Capital account.

Small versus large share dividends.

A. Small share dividend.

 A share dividend of less than 20% of the number of shares previously

outstanding
 Companies must transfer from retained earnings to ordinary share and share
premium accounts an amount equal to the fair market value (based on post-
declaration share price) of the additional shares issued.

Illustration: Nestle Philippines is blessed with years of profitable operations for its
commitment to serve affordable and healthy food favorites. The declaration of a 10%
share dividend will require the issuance of an additional 2,000 shares. Assume that the

3
 company’s share is being traded at the stock exchange and that the stock market price
per share is P110. The fair market value of the shares to be distributed is P 220,000.
The entries will be:
Retained Earnings 220,000
Share Distributable 100,000
Share Premium 120,000
To record declaration of 10% share dividends.

Share Distributable 100,000

Ordinary Shares 100,000
To record issuance of share dividends.

Retained Earnings (or the temporary account, Share Dividends Declared) is

debited for the fair market value of the share dividends. Share Distributable is
credited for the par value of the shares to be distributed and Share Premium for the
balance.

B. Large share dividend.

 Involves the issuance of more than 20%.
 Results in the par or stated value of the newly issued shares being
transferred to the ordinary shares account from retained earnings.

Illustration: Assume instead Nestle Philippines declared 20% share dividend on its
20,000 issued and outstanding P50 par value share. The company will issue additional
4,000 shares due to the share dividend. The entries will be:
Retained Earnings 200,000
Share Distributable 200,000
To record declaration of 20% share dividends

Share Distributable 200,000

Ordinary Shares 200,000
To record issuance of share dividends

Note:
Kindly check out your study planner. To indicate that you have finished grasping the key points at
this part of the module, tick on the checklist for Retained Earnings. This is a form of self -
assessment so you can personally monitor your learning progress.

Self-Check

1. Oledan Corp. earned P1,450,000 during the first year of its operations. Prepare an entry
to close the income to the Retained Earnings account.

2. SAJORDA Corp., a corporation with listed shares, declares a 10% share dividend (less than
20%). It has 10,000 shares issued and outstanding with par value of P100. On the date of
declaration, the market value per share is P105. Prepare the necessary journal entries.
Refer to the Answer Key.

4
 ANSWERS KEY

OLEDAN
Income and Expense Summary P 1,450,000
Accumulated Profits or Losses (Retained Earnings) P 1,450,000
To close profit to Accumulated Profits (Losses).

SAJORDA
Upon Declaration
Accumulate Profits (Losses) (1,000 x P105) P105,000
Share Dividends Distributable (1,000 x shares x P 100) P100,000
Share Premium from Share Dividend (1,000 shares x P 5) 5,000

Upon Distribution
Share Distributable 100,000
Share Capital 100,000

The amount of Accumulated Profits (Losses) to be transferred to Share Capital is based on P105 per
share which is the market value and not at P100, its par value. The number of shares to be issued as
share dividends is 1,000 shares (10,000 shares x 10%).