4.

1 Retained earnings

According to International Financial Reporting Standards (IFRS):                                        

Retained earnings are the corporation's accumulated profits over the years.                                            

It represents the cumulative balance of the following:                                            

1. Net income or loss for the period

2. Dividends distributions

3. Prior period errors

4. Change in accounting policy

5. Reclassifications of some component of other comprehensive income

6. Other capital adjustments

The normal balance of which is credit.                                             

A debit balance in the retained earnings means "deficit". The deficit is the corporation's accumulated
losses and is deducted from shareholders' equity.  

Retained earnings are presented in the Statement of financial position under the Shareholder's equity
section.                                               

Let us apply the concepts by solving the illustrative problem.                                             

Related data of Marian Corporation:                                    

Period              Net Income                

2016                1,000,000                  

2017                2,000,000                  

2019                4,000,000                  

Total                10,000,000                

During 2020, the company's total revenue is P7,000,000.              

Total expenses (including tax expense) are               P4,500,000                

Dividends declared during the year is                        1,825,000                  

What is the ending balance of retained earnings?

Determine the net income for 2018:                                    

Sales revenue                         P7,000,000                 

Less: Total expenses               4,500,000                  

Net income                            2,500,000                   

The related closing entries for temporary accounts and dividends.                                    

                                    Debit               Credit 

Sales revenue              7,000,000                  

Expenses                                            4,500,000       

Income summary                                2,500,000       

             To close temporary accounts to income summary.                         

Income summary        2,500,000                   

Retained earnings                               2,500,000       

             To close the income summary.                                

Retained earnings       1,825,000                   

Dividends payable                               1,825,000      

             To record dividends declared.                                  

Using the T- account, the ending balance of the Retained earnings in 2020:                           

4.2 Retained earnings Appropriated and Unappropriated

There are two kinds of retained earnings, namely:                                                  

1. Unappropriated Retained earnings - these represent the portion of retained earnings that is free
and can be declared as dividends to shareholders.

2. Appropriated Retained earnings - these represent the portion of retained earnings that is
restricted for dividends declaration.

Therefore, only Unappropriated Retained earnings can be distributed as dividends to shareholders.       

Note: No cash is involved in the appropriation of retained earnings, only a restriction in the distribution
of dividends will occur.                                                  

The BOD can restrict the retained earnings through the following reasons:                                   

1. Purchase of treasury shares

2. Working capital requirements

3. Long-term investments such as Plant expansion

4. Retirement of bonds

Pro-forma journal entry:                                           Debit   Credit             

To record appropriation of retained earnings:                                                         

Retained earnings - Unappropriated                         xxxxx                          

Retained earnings - Appropriated                                          xxxxx                                                 

Let us apply the concepts by solving the Illustrative problem.                                                         

Marian Corporation restricts P9,000,000 of retained earnings for the company's business expansion in
Mindanao.                              

What is the related journal entry?                                                    

How much are Marian Corporation's retained earnings?                                                    

                                                                                                                                      Debit               Credit            

Retained earnings - Unappropriated                                                 9,000,000                   

Retained earnings - Appropriated for business expansion                                        9,000,000       

            To record appropriated retained earnings.                                      

Retained earnings - Unappropriated                                                     P3,500,000                 

Retained earnings - Appropriated for business expansion         9,000,000                   

Total Retained earnings                                                                                P12,500,000               

4.3 Distribution of dividends

Dividends are the distribution of earnings or capital to the shareholders in proportion to their shares.  

2 kinds of dividends are:                                                        

1. Dividends out of earnings - these include cash dividends, property dividends, scrip dividends,
and share dividends.

2. Dividends out of capital - this includes liquidating dividends.

The three important dates to remember regarding Dividends:                                                       

1. Date of declaration - the date on which the board of directors authorizes the payment of
dividends to shareholders.

The related journal entry is Debit Retained earnings and Credit Dividends payable.                     
 2. Date of record - the date on which the stock and transfer book will be closed to registration.
Only those registered shareholders at the date of record will receive dividends. No entry is
required.

3. Date of payment - the date on which the dividend liability is to be paid. The related journal
entry is Debit Dividends payable and Credit Cash / Property/ Share capital.

4.3.1 Cash dividends

Dividends out of earnings are in the form of:                                                           

1. Cash dividends

2. Property dividends

3. Scrip dividends

4. Share dividends

Cash dividends - the most commonly distributed dividends. Under this form, cash is distributed to
shareholders.                                                 

Pro-forma journal entries:

Date of declaration:                                                   

                                                Debit   Credit             

Retained earnings       xxxxx                          

Dividends payable                        xxxxx                

Date of payment:                                                       

Dividends payable     xxxxx                          

Cash                                                    xxxxx                

Let us apply the concepts by solving the illustrative problem.

On October 8, 2020, BOD declares a cash dividend of 20%  for issued shares of 100,000

with a par value per share of P10.                            

The date of the record is October 31, 2020, and will be paid on December 31, 2020.                   

Requirement: Provide the related journal entries                

4.3.2 Property dividends

Property dividends - are the distribution of earnings to shareholders in the form of non-cash assets.    

Keynotes:

1. Noncash assets as dividends (property dividends) are recorded at the fair value of the asset to
be distributed.

2. Any increase or decrease in the fair value of the asset to be distributed from the date of
declaration up to the date of payment is reflected directly to the Retained earnings account.

3. A Gain or loss on the distribution of property dividends is recognized at the date of payment.
This is the difference between the fair value of the property dividends and the cost of the
property dividends.

Pro-forma journal entries:

Date of declaration:

                                                                                    Debit   Credit             

Retained earnings                                                       xxxxx                          

Dividends payable                                                                   xxxxx              

                                                           
Year-end adjustment to reflect changes in fair value:

Retained earnings                                                       xxxxx                          

Dividends payable                                                                   xxxxx              

Date of payment:

Dividends payable                                                       xxxxx                          

Investment in equity securities / Inventory                            xxxxx              

Gain on the distribution of property dividends                    xxxxx              

Let us apply the concepts by solving the illustrative problem:

On October 8, 2020, BOD declares property dividends with carrying value of P1,000,000            

The date of the record is October 31, 2020, and will be paid on December 31, 2020.                               

The property dividends are shares from Dingdong Corporation (Investment in equity securities). The
related fair value of the shares:                                                         

 October 8, 2020         1,200,000                                          

December 31, 2020    1,500,000                                          

Requirement: Prepare the related journal entries.  

4.3.3 Scrip dividends

Scrip dividends - At the date of payment, the corporation does not have enough cash so the dividend is
in the form of liability.                                                   
Retained earnings are still debited but Scrip dividends payable is credited. Upon payment, interest
expense is also recorded.                                                        

Scrip is like a note which is formal evidence of indebtedness to pay a sum of money for some future
time.                                                           

Illustrative journal entries:

Declared dividends of 1,000,000:                              

                                                            Debit               Credit             

Retained earnings                  1,000,000                               

Dividends payable                                            1,000,000                   

Date of payment (no cash available):                                               

Dividends payable               1,000,000                               

Scrip dividends payable                             1,000,000                   

Scrip with an interest of 2% per month.                                

After 2 months, the corporation paid the dividends in cash:                                                

Scrip dividends payable           1,000,000                               

Interest expense                                                 40,000                                    

Cash                                                                           1,040,000                   

4.3.4 Share dividends

Share dividends - these are distributed to shareholders in the form of the corporation's share.             

There are 2 kinds of share dividends namely:                                                          

Small share dividends - Declared share dividends are Less than 20% of shares outstanding shares.
Retained earnings are debited at fair value.    

Large share dividends - Declared share dividends are at least 20% of shares outstanding shares. 
Retained earnings are debited at par value.

           
At the date of declaration, Retained earnings are still debited on an amount depending on the 20%
criteria but this time Share dividends payable or Share dividends distributable is credited.

Share dividends payable is not a liability account but it is an addition to legal capital or shares capital.

Pro-forma journal entries:

                                                            Debit   Credit

Date of declaration:

Retained earnings                   xxxxx                                      

Share dividends payable                     xxxxx (at par value)

Share premium                                         xxxxx (if there is an excess)                           

Date of payment:                                                       

Share dividends payable    xxxxx                                      

Share capital                                           xxxxx                          

Let us apply the concepts by solving the illustrative problem 1:

On October 8, 2020, the BOD declares share dividends of 15,000 shares with a fair value of P15

each and a par value of P10 each. The total outstanding shares are 100,000.

The date of the record is October 31, 2020, and will be paid on December 31, 2020.        

What are the related journal entries?                                                          

Compute first the percentage:      

At the end of the year, the number of shares issued and outstanding is now 115,000.
 

Illustrative problem 2:

On October 8, 2020, the BOD declares share dividends of 20,000 shares with a fair value of P15

each and a par value of P10 each. The total outstanding shares are 100,000.

The date of the record is        October 31, 2020, and will be paid on December 31, 2020.

What are the related journal entries?                                                          

Compute first the percentage:

At year-end, how many are the shares outstanding?              

4.3.5 Liquidating dividends

Liquidating dividends - dividends out of capital.                                                                

These are paid to the shareholders when the entity is dissolved and liquidated.                                        

Trust fund doctrine - states that during the lifetime of the entity, it is illegal to return capital to
shareholders.                                                                       

Hence, the related journal entry is a debit to Share capital and a credit to Cash.                                      

The exception to the rule: Wasting assets entity                                                                  

Wasting asset entity - is an entity engaged solely or substantially in the exploitation of natural
resources.                                                                       

Wasting asset entity can declare dividends to the extent of:                                                                     

1. Retained earnings

2. Accumulated depletion (charged to Capital liquidated account)                                                 

Preference as to assets - the preference shareholders are entitled to payment for liquidation value and
dividends in arrears.                                                  

Preference as to dividends - the preference shareholders are entitled to receive first on the dividends
upon declaration.                                                    

1. Noncumulative preference shares - dividends received are only current or the year it is
declared.

2. Cumulative preference share - dividends are accumulated, once a declaration occurs, the
dividends received includes not just the current year but also the prior period (undeclared
dividends).                                    

3. Nonparticipating preference share - dividends equal to the fixed rate only (e.g. P1,000,000 *
10% = P100,000)

4. Participating preference share - dividends receive is in excess of the fixed rate.

Dividends in arrears usually include current dividends.                                          

4.5 Book value per share and Earnings per shares

Book value per share - It measures the amount that would be distributed to holders of each share if all
assets were sold at the carrying amount after all creditors were paid off.                                                 

Ordinary Shareholder's equity                                              xxxxx                                      

divided by no. of ordinary share outstanding              xxxxx                                      

Book value per ordinary share                                               xxxxx                                      

Preference Shareholder's equity                                            xxxxx                                      

divided by no. of preference share outstanding            xxxxx                                      

Book value per preference share                                           xxxxx                                      

Keynotes:                                                                   
 1. The excess over par of the shareholders' equity section will be distributed to preference and
ordinary shares

Total Shareholders' equity                                               xxxxx                                      

Less: Preference shares                                                    xxxxx                                      

Less: Ordinary shares                                                          xxxxx                                      

Shareholders' equity - Excess over par                      xxxxx                                      

2. If all are ordinary shares, then, the excess over par is distributed to ordinary shareholders.

The problem arises if there are preference shares. The distribution of the excess will be based on the
features of preference shares.                                                          

Basic earnings per share – Earnings form the basis for dividends payments and future increases in the
value of a share of stocks.

Formula: (Net income less preferred dividends) / by outstanding ordinary shares.            

Dividends per share – Dividends paid divided by the number of shares outstanding.

4.6 Summary

1. Retained earnings are the corporation's accumulated profits over the years. It represents the
cumulative balance of the net income or loss for the period, dividends distributions, prior period
errors, change in accounting policy, reclassifications of some component of other
comprehensive income, and other capital adjustments

2. There are two kinds of retained earnings, the unappropriated Retained earnings, and the
Appropriated Retained earnings.

3. Dividends are the distribution of earnings or capital to the shareholders in proportion to their
shares. It can be Dividends out of earnings and Dividends out of capital.

4. Book value per share measures the amount that would be distributed to holders of each share if
all assets were sold at the carrying amount after all creditors were paid off.

5. Basic earnings per share are earnings form the basis for dividends payments and future
increases in the value of a share of stocks.