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Accounting II | © |
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© 1989 John Petroff
PAID-IN CAPITAL
The paid-in capital section of a balance sheet provides
information on the type of shares issued, and whether or not any
premiums or discounts was present. Also reported are the number
of shares authorized and the number of shares issued.
There are many acceptable variations in reporting shareholders'
equity on the balance sheet. Premium paid-in capital accounts
may
be combined into a single heading called additional paid-in
capital or listed separately. Any significant changes that occur
to the paid-in capital section of the balance sheet should be
disclosed in financial statements.
CORPORATE EARNINGS AND INCOME TAXES
Net income or loss is determined for corporations in a similar
fashion to other business enterprises. Corporations are required
to make advance quarterly payments for income taxes. These
payments are only estimates, and adjustments are necessary at
the
end of the year. If advance payments exceed the tax liability,
a
receivable account is debited. If tax liabilities exceed advance
payments, a payable account is credited. Tax authorities are
permitted to review income tax returns up to three years after
they have been filed. Because income tax expenses are determined
on net income, they are usually the last expense reported on
the income statement.
ALLOCATING INCOME TAXES BETWEEN
PERIODS
The taxable income of a corporation is usually calculated differently
for tax and financial statement purposes. These differences in
reporting can be permanent or due to timing. A permanent difference
is
caused by a different treatment of a revenue or an expense. For
example, certain types of revenue may not be taxable, and certain
allowable deductions may not be actual expenses. Timing differences
commonly occur when sales are made on an installment basis, or
revenue
is earned from long-term projects, and when the depreciation methods
use for tax and financial statement purposes differ. Corporations
in
such circumstances tend to accelerate expenses, and defer income
to
future years when reporting for tax purposes. The opposite approach
is
taken when accounting for financial statements.
UNUSUAL ITEMS IN FINANCIAL STATEMENTS
Unusual items are not commonly reported on the income statement.
Unusual items are for instance: prior year income adjustments,
extraordinary gains or losses, effects of a change in accounting
methods, and gains or losses from discontinued operations.
PRIOR PERIOD ADJUSTMENTS
Minor accounting errors are usually caused by the use of
estimates. These errors are considered to be normal and are
also recurring. The effects of these errors should be
reflected in the accounts of the current period. Material
errors are caused by mathematical errors, improper use of
accounting principles, misuse of facts, etc. The treatment
of material errors depends on when they have been discovered.
PRIOR PERIOD ADJUSTMENTS
When a material error is discovered in the period it occurred,
the following procedures should be followed: 1) post the error
in a journal entry, 2) post the correct journal entry, and
3) determine the debit and credit adjustments needed to bring
the correct balance to accounts. When material errors are not
discovered in the same period they have occurred, an adjustment
must be made to the retained earnings balance.
PRIOR PERIOD ADJUSTMENTS
Prior period adjustments are recorded immediately after the beginning
balance of retained earnings. Prior period adjustments are made
net
of any income tax. Past balance sheets and income statements should
be corrected. Actual prior period adjustments are rare due to
the
strict internal controls of accounting systems and audits performed
by independent accountants.
DISCONTINUED OPERATIONS
When a segment of a business is disposed, a gain or loss may be
realized. This gain or loss should be reported on the income
statement under discontinued operations. It is customary to report
the results of continuing operations first. In addition to gain
or
loss information, the following should also be disclosed in the
financial statements: the disposal date, which assets and liabilities
were effected, the manner of disposal, and the identity of the
segment.
EXTRAORDINARY ITEMS
Extraordinary items are events or transactions which are unusual
in
nature and do not occur frequently. Gains and losses from disposal
of plant assets or selling investments do not qualify as extraordinary
because they are considered to be normal business activities.
Two distinct approaches are used for extraordinary items. The
all-inclusive theory recommends that both ordinary and extraordinary
items be included in the income statement; it is the most commonly
followed. The current operating performance theory recommends
that
only normal, ordinary, and recurring items be listed on the income
statement, and extraordinary items be shown in retained earnings.
CHANGES IN ACCOUNTING PRINCIPLES
When a company changes one of its accounting methods, the change
must be disclosed in the financial statements of a company. The
reasoning for the change, the effect on net income, and the
justification of the change all should be disclosed. The
disclosure should indicate the cumulative effect of the change
on
net income of prior periods and the current period. The cumulative
effect on income is usually found listed after extraordinary items.
EARNINGS PER COMMON SHARE
Although absolute amounts are very helpful in evaluating a company's
performance, it is not useful in comparing companies of different
sizes. Earnings per common share is determined by dividing net
income
by the number of outstanding common shares. If there are any
outstanding preferred stock, their dividends should be subtracted
from
net income before calculating EPS.
EARNINGS PER COMMON SHARE
Many corporations issue both debt and equity instruments. When
bonds and preferred stock have conversion privileges, two EPS
figures should be calculated. The first (called primary EPS)
assumes no conversion has taken place, and the other (called
fully diluted EPS) assumes all conversion privileges are used.
EPS information can be found at the bottom of an income
statement. It considers both activities from continuing
operations and nonrecurring items.
RETAINED EARNINGS APPROPRIATIONS
Portions of retained earnings which are restricted to specific
uses, are called appropriations or reserves. The board of
directors commonly makes decisions regarding appropriations,
or they may be required by laws or contracts. When an
appropriation is called for, retained earnings is debited and
an
appropriation account credited. Appropriations are commonly
classified as either contractual or discretionary.
RETAINED EARNINGS APPROPRIATIONS
Contractual appropriations restrict the use of retained
earnings under specified conditions. For example, common stock
dividends will not be paid unless all bondholders receive their
interest payments. Discretionary appropriations are voluntary
decisions. Most appropriation accounts are not related to
specific assets. A funded appropriation is commonly accompanied
by a specific current asset.
RETAINED EARNINGS APPROPRIATIONS
The purpose of appropriations should be indicated in the balance
sheet. Losses should never be posted to an appropriation account,
but to a special loss account. The retained earnings statement
is
divided into two sections: 1) appropriated funds and
2) unappropriated funds. The last figure on the retained earnings
statement shows the ending balance of the retained earnings
statement.
CASH DIVIDENDS
Before cash dividend payments can be made, three prerequisites
must be met:
1) the board of directors declares them,
2) a sufficient cash balance is on hand, and
3) a sufficient unappropriated retained earnings balance exists.
The following three dates are associated with any declaration:
1) declaration date, 2) date of record, and 3) date of payment.
The declaration date is when the board of directors decides to
make cash dividend payments. The date of record is when a list
is
compiled of owners of shares. The date of payment is when checks
are mailed out to all shareholders.
CASH DIVIDENDS
A declaration of a cash dividend becomes a liability at the date
of declaration and requires a journal entry. Cash dividends
are debited and cash dividends payable credited. On the
date of payment, cash dividends payable is debited and cash
credited.
CASH DIVIDENDS
Corporations which have a stable dividend record are very attractive
to
investors seeking a steady flow of investment income. Dividends
can be
paid out on a quarterly, semi-annual or annual basis. In years
when
earnings are higher than normal, common shares may be eligible
to
receive an extra dividend. The declaration of dividends is at
the sole
discretion of the board of directors. In the event cumulative
preferred
stock exists and dividends are in arrears, no dividend payments
can be
made to common shareholders until preferred shareholders have
received
all dividends in arrears.
STOCK DIVIDENDS
Stock dividends are usually issued to holders of common stock,
and are in the form of common stock. No cash or other corporate
asset is distributed through stock dividends. A stock dividend
alters the capital structure of a company by transferring
accumulated retained earnings to paid-in capital. Stock dividends
are commonly used by corporations which wish to use their funds
for expansion purposes instead of cash dividends. The issuance
of
stock dividends does not effect asset, liability, or the total
stockholders' equity balance of a company.
STOCK SPLITS AND SPECIAL DIVIDENDS
Stock splits reduce the par or stated value of a corporation's
common stock, by issuing a proportionate number of additional
shares. The purpose of stock splits is to reduce the market
value of shares and encourage more investors to purchase shares
of stock. Shareholders do not lose any equity or fractional share
of company ownership. Stock splits do not change any asset,
liability, or shareholders' equity balances of a corporation.
No
journal entry is needed for stock splits.
STOCK SPLITS AND SPECIAL DIVIDENDS
Liquidating dividends are paid out of paid-in capital accounts.
These dividends are most commonly issued when a company reduces
its operations or closes down completely. Stock that has been
issued and repurchased by a corporation, i.e. treasury stock,
receives no cash dividends. Stock dividends can be based on
either the number of shares issued or the number of shares
outstanding. The same option is available for stock splits.
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