Accounting 3 & 4

Module 8 - Shareholders’ Equity, Retained Earnings, and Dividends

Shareholders’ Equity

The capital section of a corporation is known as shareholders’ equity, stockholders’ equity or net worth.
It represents the residual interest of the owners in the net assets of the corporation. It is measured by
the excess of assets over liabilities.

The following constitute the shareholders’ equity:

1. Share Capital or Capital Stock. This represents the total par value or stated value of the shares or
stocks issued. If there are two classes of shares in a corporation such as Preference Share or
Preferred Stock and Ordinary Share or Common Stock, each must be shown separately.
2. Subscribed Share Capital or Subscribed Capital Stock. The portion of the authorized capital stock
already subscribed but not yet fully paid.
3. Additional Paid-in Capital. This represents the portion of capital invested by the shareholders in
excess of the par value or stated of the subscribed shares or subscribed stocks. Examples of this
are: Premium on Ordinary Share (Common Stock) and Capital Excess over Stated Value.
4. Revaluation Increment in Property. The excess of sound value over the net book value.
Sound value is the appraised value of the asset minus the observed depreciation.
Net book value is the historical cost of the asset minus accumulated depreciation.
5. Donated Capital. This represents the capital originating from stockholders or from persons other
than the stockholders in the form of stocks or other assets given to the corporation as a gift or
donation.
6. Treasury Share or Treasury Stock. This refers to share or stock owned by the corporation which
has been issued and fully paid up and later reacquired by the same corporation but not
cancelled. This kind of share or stock is not entitled to receive dividend, has no voting right and
has no right to share in the assets of the corporation in case of liquidation.
7. Retained Earnings. This refers to the accumulated income of the corporation from the time it is
incorporated minus the dividends distributed to the shareholders as well as losses incurred by
the business.

Retained Earnings

There are two types of Retained Earnings, namely:

1. Unappropriated or Free Retained Earnings. This portion of retained earnings is not earmarked
for any purpose, and therefore can be the basis for dividend declaration.
2. Appropriated Retained Earnings. This portion of the retained earnings is earmarked for certain
specific purposes such as: for contingencies, for plant expansion, for redemption of bonds, for
pending law suits, and for sinking fund purposes. Appropriation of retained earnings may be
made at the discretion of the Board of Directors or it may be required by law.

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 The entry to record appropriation of retained earnings would be:

Retained Earnings Phpxxx

Retained Earnings Appropriated for Treasury Shares Phpxxx

If after a few days, the corporation sold its treasury shares, the entry above must be reversed
because the appropriation is no longer needed. The entry to transfer it back to Retained Earnings would
be:

Retained Earnings Appropriated for Treasury Shares Phpxxx

Retained Earnings Phpxxx

Importance of Retained Earnings Account

In a sole proprietorship, the balance of the Revenue and Expense Summary account is closed directly to
the capital account of the sole proprietor, except if there is a drawing account in which case, it would be
closed first to drawing account and finally to capital account. The same is true with a partnership, where
income or loss is transferred to the partners’ capital account depending on the agreement as to how
profits will be distributed among them.

In a corporation, at the end of the accounting period, the income or loss is closed to the Retained
Earnings account. The Share Capital or Capital Stock is not decreased by losses incurred nor increased by
profits realized by the corporation. The amount of the paid-in capital of the shareholders is maintained
in order to protect the creditors of the corporation; and this can be returned to the shareholders only in
case of dissolution and only after all the debts have been paid.

For example, if ABC Corporation earned Php1,000,000 during the year, the entry to transfer the balance
of the Revenue and Expense Summary account to Retained Earnings would appear as follows:

Dec. 31 Revenue and Expense Summary Php1,000,000

Retained Earnings Ph1,000,000

Deficit is a debit balance of the retained earnings account. It is a deduction from shareholders’ equity.

Meaning and Nature of Dividend

The term dividend means distribution of earnings by a corporation to its shareholders in proportion to
the number of shares owned. Declaration of dividend is discretionary on the part of the Board of
Directors. Dividends may be expressed as a certain percentage of the total par value (computed by
multiplying the number of shares owned by the par value per share x %), or in the case of no- par share,
dividend may be stated as a certain amount per share, such as dividend of Php5 per share.

Dividends are commonly paid in the form of cash. In cases where the company has an insufficient cash,
dividend may be paid in assets other than cash.

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Types of Dividends

Dividends are of two types, namely:

1. Dividends Out of Earnings. This refers to the portion of the corporate profits or earnings
declared by the Board of Directors payable to the shareholders of record as of a given date. This
is usually based on the balance of the unappropriated retained earnings.
2. Dividends Out of Capital. Another term for this kind of dividend is liquidating dividend, which
means distribution to shareholders out of the paid in capital. This is in accordance with the
wasting assets doctrine which permits distribution of dividends out of capital. This doctrine is
applicable to wasting assets corporation such as a mining company.

The trust fund doctrine is in contrast with the wasting assets doctrine. According to this concept,
no dividend shall be paid out of the legal or stated capital because this constitute a trust fund
for the payment of debts.

Significant Dates in Dividends Declaration

1. Date of Declaration. The date when the Board of Directors formally declared and authorized the
distribution of dividend to the shareholders.
2. Date of Record. On this date, ownership of shares is determined and a list of shareholders entitled
to receive dividend is made.
3. Date of Payment. The date when dividend is payable to shareholders.

To illustrate, on July 1, the Board of Directors of Ang Tibay Corporation, declares a quarterly
dividend of Php8.00 per share to shareholders of record as of July 31 payable on September 15.
Notice of dividend declaration is sent to the shareholders.

In the above example, the date of declaration is July 1, the date of record is July 31, and the date of
payment is September 15.

Before any dividend declaration can be made, there are three requisites, namely:

1. adequate free unappropriated retained earnings

2. adequate cash position
3. formal action by the board of directors

Kinds of Dividends Out of Earnings

Cash Dividend. This is the most common type of dividend. Dividend on ordinary shares (commons
stocks) is usually expressed in terms of certain amount per share, such as Php10.00 per share. On the
other hand, dividend on preference shares (preferred stocks) is usually stated as a certain percentage of
the par value of the total shares issued. The dividend rate is a fixed rate which denotes preference as to
dividend. For, if shareholder A owns 750 preference shares which has a fixed dividend rate of 8% and
with par value of Php100 per share, the amount of dividend to be received by A is Php6,000 (750 x
Php100 x .08).

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Illustration:

Assume that on September 15,200A, the Board of Directors of ACT Corporation declares a 6% dividend
on the shares with par value of Php100 per share to shareholders of record on November 15, 200A. The
issued and outstanding shares totaled 1,000 shares and said dividend is to be paid on December 31 of
the same year.

Journal entries in the books of the corporation:

200A
Sept. 15 Dividends or Retained Earnings Php6,000
Cash Dividends Payable Php6,000
To record the declaration of dividends.
(1,000shares x Php100par x .06)

On the date of record, that is November 15, no entry is necessary in the books of the corporation. The
transfer book is closed and a list of shareholders who are entitled to receive dividend is taken.

200A
Dec. 31 Cash Dividends Payable Php6,000
Cash Php6,000
To record the payment of dividends.

On the date of payment, the liability account “Cash Dividend Payable” is closed since the dividend has
already been paid. The account “Dividend” is closed to Retained Earnings at the end of the year.

Property Dividend. This is a kind of dividend distributed to the shareholders in the form of properties or
non-cash assets owned by the corporation.

On the date of declaration, the journal entry would appear as follows:

Dividends or Retained Earnings Phpxxx

Property Dividends Payable Phpxxx

On the date of payment, the entry is:

Property Dividends Payable Phpxxx

Appropriate Non-cash Assets Phpxxx

The corporation paying the property dividend should record the dividend at book value or cost of the
property distributed and not on market value.

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Illustration:

The following is an abstract of the shareholders’ equity section of Halina Corporation’s balance sheet:

Ordinary Share:
Authorized shares 3,000
Unissued shares _ 400
Outstanding shares 2,600
Less: Treasury shares 100
Issued and Outstanding 2,500 Php50,000
Retained Earnings 35,000
Total Shareholders’ Equity Php85,000

Halina Corporation owns 2,500 shares of Marina Co. at a cost of Php20.00 per share. These shares have
market value of Php25.00 per share.

The directors of Halina Corporation declared dividend of 1 share of Marina Co. shares for every 5 shares
owned.

When property dividend is declared, the journal entry is:

Retained Earnings Php10,000

Property Dividends Payable Php10,000
To record dividend declaration.
(2,500 shares/5 = 500 shares x Php20.00 = Php10,000)

On the date of payment, the entry is:

Property Dividends Payable Php10,000

Investment in Shares of Marina Co. Php10,000

Note: The shares of Marina Co. distributed by the corporation is recorded at a cost of Php20.000 per
share and not on current value of Php25.00.

Stock Dividend. A kind of dividend which involves the distribution of company’s shares. A transfer of
Retained Earnings to Paid- in Capital is effected in this type of dividend, hence, the balance of the
Retained Earnings is decreased, but the cash account and other assets of the corporation remain the
same.

To illustrate, assume that the Shareholders’ Equity of Marben Corporation appears below:

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Ordinary Shares
Authorized 5,000 shares; 3,000 shares issued and outstanding; par value Php80 Php240,000
Premium on Ordinary Shares 45,000
Retained Earnings 200,000
Php485,000
A share dividend is declared by the Board of Directors on June 15, payable on July 15.

200A
June 15 Retained Earnings Php60,000
Share Dividends Payable Php60,000
To record dividend declaration.
(25% x 3,000 shares = 750 shares x Php80)

On the date of payment, share certificates are issued to the shareholders. This is recorded by the
following entry.

July 15 Share Dividends Payable Php60,000

Ordinary Shares Php60,000

Liability Dividend. There are instances when the corporation is unable to pay cash dividends even if the
balance of the Retained Earnings is sufficient to cover such dividends. This may be due to insufficient
balance of cash which may not be even enough to meet working capital requirements.

Liability dividends are dividends in the form of bonds or scrip resorted to by the corporation when it is
unable to pay cash dividends to its shareholders. There are two examples of liability dividend, namely:
scrip dividend and bond dividend.

Scrip Dividend is a certificate of indebtedness which may or may not be interest- bearing and usually on
a short-term basis.
Bond Dividend is a certificate of indebtedness which is usually interest-bearing and on a long-term basis.

Accounting for Cash Dividend

When the corporation has two kinds of share, the computation of dividend owing to the preference and
ordinary shareholders will depend on the type of preference share as to whether they are:

1. Cumulative, non-participating
2. Non-cumulative, non-participating
3. Non-cumulative, fully participating
4. Cumulative, fully participating
5. Cumulative and fully participating to a certain percentage

Cumulative. A preference share is cumulative if it is entitled to past dividend or dividend in arrears in

addition to the current year dividend. If today is 200C and the corporation has not declared dividend
since 200A, a cumulative preference shareholder will be entitled to dividend for 3 years.

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Non-cumulative. A preference share entitled to receive only the dividend pertaining to the current year.
If the board of directors did not declare dividend since 200A and in 200C a 10% cash dividend is
declared, then non-cumulative preference shareholder will be entitled only to the dividend for 200C.

Participating. A preference share is participating if it is entitled to receive dividend in excess of the fixed
rate mentioned in the share certificate.

Non-participating. A preference share entitled to dividend which is equal to the fixed rate as stated in
the share certificate. In this type of preference share, the remaining balance of the Unappropriated
Retained Earnings will be given to the ordinary shareholders after the preference shareholders received
their share.

In order to have a clear understanding as regards to the amount of dividend in case where the
corporation issued both preference and ordinary shares, the following illustration will be discussed:

Assume the following data gathered from the ledger of POPS Corporation

8% Preference Shares, authorized 1,500 shares; issued and outstanding

1,000 shares at Php100 par value Php100,000
Ordinary Shares, authorized 4,300 shares; issued and outstanding
4,000 shares at Php50 par value 200,000
Retained Earnings (unappropriated) 50,000

Required: Compute the amount of dividend distributable to both preference

and ordinary shareholders under each of the following conditions
with respect to preference shares:
a. Cumulative, non-participating
b. Non-cumulative, non-participating
c. Non-cumulative, fully participating
d. Cumulative, fully participating
e. Cumulative, participating up to 12%

Assume also that the whole amount of Php50,000 was declared and that the board of directors did not
authorize payment of dividend since 200A.

a. Preference share is cumulative and non-participating

Preference Share Ordinary Share
.08 x Php100,000 x 3 years Php24,000 Php ---
Balance (Php50,000 - Php24,000) 26,000
Php24,000 Php26,000

Since the preference share is cumulative, it is entitled to dividend in arrears for the years 200A
and 200B plus the current year dividend for 200C. After the preference dividend has been given,
the balance of the Retained Earnings will go to the ordinary shareholders.

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b. Preference share is non-cumulative and non-participating
Preference Share Ordinary Share
.08 x Php100,000 x 1 year Php8,000 Php---
Balance (Php50,000 – Php8,000) 42,000
Php8,000 Php42,000

Non-cumulative preference share is entitled only to dividend of the current year; so any balance
of the Retained Earnings will be given to ordinary shareholder.

c. Preference share is non-cumulative and fully participating

Preference Share Ordinary Share
.08 x Php100,000 x 1 year Php8,000 Php---
,08 x Php200,000 x 1 year --- 16,000
Balance for participation:
(Php50,000 – Php24,000 = Php26,000)
Php100,000 1/3 x Php26,000 8,667 ---
200,000 2/3 x Php26,000 17,333
Php300,000 Php16,667 Php33,333

After giving the preference shareholders their dividend shares, the ordinary shares should also
be given the same rate which should be based on the total par value of the ordinary shares.
Then the balance should be divided between the preference and ordinary shares in the ratio of
their outstanding shares or 1:2 respectively.

d. Preference share is cumulative and fully participating

Preference Share Ordinary Share
.08 x Php100,000 x 3 years Php24,000 Php ---
.08 x Php200,000 x 1 year --- 16,000
Balance for participation
(Php50,000 – Php40,000 = Php10,000)
1/3 x Php10,000 3,333 ---
2/3 x Php10,000 6,667
Php27,333 Php22,667

e. Preference share is cumulative and participating up to 12%

Preference Share Ordinary Share
.08 x Php100,000 x 3 years Php24,000 Php ---
.08 x Php200,000 x 1 year --- 16,000
Balance for participation
(Php50,000-Php40,000 = Php10,000)
.04 x Php100,000 4,000 ---
(Php10,000 – Php4,000) 6,000
Php28,000 Php22,000

Since the preference share is participating up to 12%, this means that for the current year, 200C,
it is entitled to receive Php12,000 which is 12% of Php100,000. So, in the balance for
participation, the preference share will still receive Php4,000 determined by multiplyimg 4% by
Php100,000; the remaining balance will be for the ordinary shares.

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Exercises

1. An abstract of the shareholders’ equity of the Camia Co. on December 31,200A appears as
follows:
Preference Share, Php35 par value, 150,000 shares issued and
outstanding Php5,250,000
Ordinary Shares, Php25 par value, 300,000 shares issued and
Outstanding 7,500,000
Premium on Preference Share 450,000
Premium on Ordinary Share 600,000
Retained Earnings 1,200,000
Treasury Share – Ordinary 60,000

The Board of Directors decided to establish a reserve of Php230,000 for contingencies and
Php380,000 for plant expansion.

Required:
1. Record the appropriation of Retained Earnings.
2. Prepare the shareholders’ equity section of Camia Corporation
2. The share equity of Brookside Corporation on January 1 of the current year 200C is given below:

Share Capital
8% Preference Share, Php100 par value, 3,000 share authorized;
2,000 shares issued of which 250 shares are in treasury Php200,000
Ordinary Shares, Php50 par value, 5,000 shares authorized
3,500 shares issued 175,000
Additional Paid-in Capital:
Premium on Preference Share Php10,000
Premium on Ordinary Share 35,000 45,000
Retained Earnings:
Unappropriated Php75,000
Appropriated for Contingencies 20,000
Appropriated for Treasury Shares 27,500 122,500
Appraisal Capital 15,000
Total Php557,500
Less: Treasury Shares 250 shares at cost 27,500
Total Shareholders’ Equity Php530, 000

The following are the transactions that occurred during the year:

March 1 – The board of directors declared a semi-annual dividend on preference shares and
ordinary shares to shareholders of record as of June 30, to be paid on July 31. The
preference share is cumulative and no dividend have been declared since 200A.

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 June 30 – An 8% share dividend on ordinary was declared to shareholders of record as of
August 31, payable on October 15; market value of ordinary is Php58 per share.

July 31 – Paid the preference and ordinary dividends.

Oct. 15 – Distributed the share dividends to ordinary shareholders.

Required: Prepare all the entries for the above transactions.

3. The Antik Corporation has issued both preference and ordinary shares. On January 1, 200D, the
shareholders’ equity of the corporation is as follows:

6% Preference Shares, Php75 par value, authorized and Issued 40,000 shares Php3,000,000
Ordinary Shares, Php100 par value, authorized and issued 50,000 shares 5,000,000
Retained Earnings 1,500,000

Assume that dividends have not been declared since 200B.

Required:
1. Compute the amount to be distributed to preference and ordinary shareholders on each of
the following cases of preference share:
a. Non-cumulative, non-participating
b. Cumulative, non-participating
c. Non-cumulative, fully participating
d. Cumulative, fully participating
e. Cumulative, participating up to 10%
2. Prepare the shareholders’ equity section of Antik Corporation

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