65

Lesson 3: CORPORATION: RETAINED EARNINGS

Lesson Objectives:

At the end of the lesson, the students are expected to:

 To journalize the accounting for retained earnings,
 To compute the different kinds of dividends, and
 To prepare statement of changes in shareholders' equity.

Discussion and Application

Retained Earnings (Accumulated Profits) is the component of shareholders’ equity arising from the
retention of assets generated from the profit-directed activities of the corporation.
COMPOSITION OF RETAINED EARNINGS

 Profit or Loss (Case 1)

 Share capital transactions and restrictions (like treasury stock on the module 2)(Case 2)
 Dividends (Case 3)

Case 1: PROFIT OR LOSS

The basic steps in the accounting cycle for a corporation are the same as that of a sole
proprietorship and a partnership type of business. The difference, however, of corporation lies on the
equity section called "Shareholders’ Equity” primarily because it is presented according to source in
the statement of financial position. Likewise, on how to account profits/losses that the entity had made
during the period through the retained earnings. The pro-forma closing entry, if the operations of a
corporation resulted in a profit or loss, would be:

XXXX Income Summary X X X X

Retained Earnings X X X X
To record closing entries (when income)

XXXX Retained Earnings X X X X

Income Summary X X X X
To record closing entries (when loss)

Case 2: SHARE CAPITAL TRANSACTIONS AND RESTRICTIONS

TYPES OF RESTRICTIONS

1. Appropriation for contingencies – it’s a voluntary appropriations approved by the Board to be used
in case of deficit operation as well as for operation continuity like plant & segment expansion.
2. Appropriation for Bonds and Stock Redemption – a contractual appropriations set aside for provision
of redeeming stocks and bonds issued by the company.

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 66

3. Appropriation for Treasury shares – an appropriation covered by law or legal appropriations to

sustain amount of shares in the treasury.
The pro-forma entry to restrict and unrestricted the retained earnings would be:

XXXX Retained Earnings X X X X

Appropriation/Reserve for ___________ X X X X
To record appropriated earnings for _______ (when Restricting)

XXXX Appropriation/Reserve for ___________ X X X X

Retained Earnings X X X X
To record release of appropriated earnings for _______ (when UNrestricting)

On January 1 of the current year, assume DBA Corporation had the following capital structure:

Ordinary Share, P20 par, 100,000 shares,

all issued and outstanding ₱ 2,000,000
Share Premium 500,000
Retained Earnings 1,800,000

DBA gained a P280,000 net profit during the year and following are some transactions related to the
restrictions of retained earnings:
 February 4, the company reacquired its owns in the amount of P100,000.

Feb.4 Retained Earnings 1 0 0 0 0 0

Appropriation for Treasury Shares 1 0 0 0 0 0
To record appropriated earnings for acquisition of own shares

 April 8, DBA company set aside an amount of P400,000 for Bond redemption in year 2025.

Apr.8 Retained Earnings 4 0 0 0 0 0

Appropriation for Bonds 4 0 0 0 0 0
To record appropriated earnings for bond redemption

 May 15, the company allocated 200,000 pesos for future purchase of real property.

M ay.15 Retained Earnings 2 0 0 0 0 0

Appropriation for Land 2 0 0 0 0 0
To record appropriated earnings for contingency (Land)

 As of December 31, the company has treasury shares amounting to P10,000.

Dec.31 Appropriation for Treasury Shares 9 0 0 0 0

Retained Earnings (P100,000 - P10,000) 9 0 0 0 0
To record unappropriated earnings for treasury shares

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 67

STATEM ENT OF RETAINED EARNINGS

Unappropriated Earnings:
Balance, January 1 ₱ 1,800,000
Add: Net Profit 280,000
Reversal of Appropriation 90,000
Total ₱ 2,170,000
Appropriated Earnings:
Les: Net Loss -
Appropriation for Land ( 200,000 )
Appropriation for Bonds ( 400,000 )
Total ( 600,000 )
Balance, Dececmber 31 ₱ 1,570,000

Case 3: DIVIDENDS

ENTITLEMENT OF DIVIDENDS
Revised Corporation Code Sec. 42 states that all outstanding capital stock are entitled to dividends. It
means all issued, outstanding and subscribed shares are entitled to dividends except treasury shares.
TWO KINDS OF DIVIDENDS
 Ordinary dividends are dividends out of earnings (retained earnings), and
 Liquidating dividends are dividends out of Capital (will not discuss here)

COMMON FORMS OF ORDINARY DIVIDENDS

A. Cash dividends, which are distribution of cash to the shareholders;
B. Property dividends, which are distribution of non-cash assets to the shareholders;
C. Liability/Scrip, where promissory notes are distributed to shareholders; and
D. Stock dividends, also known as bonus issue, where shares of the company’s stocks are distributed to
shareholders.

THREE (3) SIGNIFICANT DATES in accounting for dividends

 Date of declaration - date when board of directors formally approves and announces the
dividends declaration. Pro-forma entry: debit Retained Earnings, credit Dividend (Asset, Liability
or Equity) Payable.
 Date of record – date selected by the board of directors is stated in the declaration. No journal
entry is required on this date.
 Date of distribution or payment is date determined by the board of directors and stated in the
declaration. The date of payment usually follows the declaration date by four to six weeks. On
this date, an entry is prepared to record the distribution as follows: debit Dividend (Asset, Liability
or Equity) Payable, credit Asset, Liability or Equity.

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 68

3A: CASH DIVIDENDS

 Most common type of dividend usually expressed at a certain amount of peso (e.g. P5 per
share, P10 per share).
 Alternatively, can be expressed at a certain percentage of the par value (e.g. 10% is declared
a dividend on a P100 par value share).

Assume that the Board of Directors of DBA Corporation declared a cash dividend of 8% per share
on July 1, 2021 to shareholders of record as of August 15, 2021, payable on September 15, 2021. Total
outstanding and issued shares: 100,000 shares at a par of P100. Journal entries in the books will be:

Date of Declaration
July.1 Retained Earnings 8 0 0 0 0 0
Cash Dividend Payable (100,000 shares x 8% x P100) 8 0 0 0 0 0
To record delaration of dividends

Date of Distribution 8 0 0 0 0 0
Sept.15 Dividend Payable 8 0 0 0 0 0
Cash
To record payment of dividends

3B: PROPERTY DIVIDENDS

 Inventories – lower of cost and net realizable value
 Trading securities – fair value
 PPE – lower of carrying value (cost minus accumulated depreciation) and fair value

Assume that the Board of Directors of DBA Corporation declared a property dividend of one share
of SOP Company ordinary share for ten 10 shares of DBA. SOP Company is held as equity investment
through profit and loss and have a carrying value per share of P50. There are 100,000 DBA ordinary
shares issued and outstanding.

Date of Declaration
July.1 Retained Earnings 5 0 0 0 0 0
Property Dividend Payable (100,000 shares / 10 x P50) 5 0 0 0 0 0
To record delaration of dividends

Date of Distribution 5 0 0 0 0 0
Sept.15 Property Dividend Payable 5 0 0 0 0 0
Equity Investment at fair value through P/L
To record payment of dividends
Note: Non-cash assets like inventories, securities held by the corporation as investment and PPE are
occasionally distribute as property dividends measured at fair value.

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 69

3C: SCRIP DIVIDENDS

 A scrip is a written promise to pay certain amount at future date plus interest until date of
payment.

 This liability dividends is declared when the corporation has sufficient retained earnings, but no
enough cash balance to pay the dividends.
Assume DBA Corporation declared a 10% scrip dividends on May 1, 2021 payable on May 1, 2022
with interest at the rate of 12%. The total par value of the outstanding shares of DBA is 1M.

Date of Declaration
M ay.1 Retained Earnings 1 0 0 0 0 0
Scrip Dividend Payable (P1,000,000 shares x 10% ) 1 0 0 0 0 0
To record delaration of dividends
Dec.31 Interest Expense 8 0 0 0
Interest Payable (100,000 x 12% x 8/12) 8 0 0 0
To record interest of scrip dividends

Date of Distribution
M ay.1 Interest Expense 4 0 0 0
Interest Payable 8 0 0 0
Scrip dividend Payable 1 0 0 0 0 0
Cash 1 1 2 0 0 0
To record payment of dividends

3D: STOCK DIVIDENDS

 A distribution of the corporation’s own stock from unissued shares.
 It is usually expressed at a certain percentage of the shares issued and subscribed.
 It is a way of capitalizing the retained earnings of the corporation (increasing Paid in Capital
and decreasing Retained Earnings)

Assume on May 1, current year, DBA Corporation has the following accounts on its equity section:
Ordinary Shares, P100 par value, 50,000 authorized,
10,000 shares issued and outstanding ₱ 1,000,000
Share Premium 200,000
Retained Earnings 550,000

TWO CATEGORY OF STOCK DIVIDENDS:

1. Small stock dividends (less than 20%), charged to retained earnings at the fair value.

A 10% dividend was declared when the market value of the stock was P150 per share.

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 70

Date of Declaration
M ay.1 Retained Earnings(10,000 shares x 10% x P150) 1 0 0 0 0 0
Stock Dividends for distribution (10,000 shares x 10% x P100) 1 0 0 0 0 0
Share Premium (10,000 shares x 10% x P50) 5 0 0 0 0
To record delaration of dividends
Date of Payment
Jul-01 Stock Dividends for distribution 1 5 0 0 0 0
Ordinary Shares 1 5 0 0 0 0
To record payment of dividends

Note: Stock Dividends for distribution has no effect in the financial position of the company. However,
it will become part of Paid in Capital on the date of payment.

2. Large stock dividends (20% or more), should be capitalized to retained earnings at the par value.

A 20% dividend was declared when the market value of the stock was P150 per share.
Date of Declaration
M ay.1 Retained Earnings(10,000 shares x 20% x P100) 1 0 0 0 0 0
Stock Dividends for distribution (10,000 shares x 20% x P100) 1 0 0 0 0 0
To record delaration of dividends

Date of Payment
Jul-01 Stock Dividends for distribution (10,000 shares x 20%
1 0x P100)
0 0 0 0
Ordinary shares 1 0 0 0 0 0
To record payment of dividends

Note: Since the stock declaration was 20%, the retained earnings was debited only at par value and
no share premium is recognized.

TYPES OF PREFERENCE SHARE

1. Non-participating – limit the holders to receive dividends for a specified rate or amount only.
2. Non-cumulative – holders are entitled only to current year declared dividends.
3. Cumulative – entitle the holders to the receipt of dividends not paid in previous year/s.
4. Fully participating – entitle the holders to the additional dividends over the stipulated rate or amount.
5. Partially participating – allow the holders to receive dividends limited to an additional rate specified
on the stock certificate.

Assume on July of the current year, DBA Corporation has the following stock issued and outstanding:
16% Preference shares, par value of P100,
20,000 shares issued and outstanding ₱ 2,000,000
Ordinary Shares, P50 par value, 500,000
10,000 shares issued and outstanding
Retained Earnings 2,450,000

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 71

Preference#1&2: On the same month, the BOD declared cash dividends of P1,200,000. No dividends
were declared for the past two years. Payment month is August.

Preference Ordinary Total

₱ 1,200,000
20,000 shares x 16% x P100 x 1year ₱ 320,000 - 880,000
Remainder to Ordinary share (1.2M -320T) - ₱ 880,000 -
₱ 320,000 ₱ 880,000

Date of Declaration
July Retained Earnings 1 2 0 0 0 0 0
Cash Dividend Payable - Preference 3 2 0 0 0 0
Cash Dividend Payable - Ordinary 8 8 0 0 0 0

Date of Payment
August Cash Dividend Payable - Preference 3 2 0 0 0 0
Cash Dividend Payable - Ordinary 8 8 0 0 0 0
Cash 1 2 0 0 0 0 0

Note: Since preference share is non-cumulative and non-participating, the share in the dividends of
the preferred shareholders is limited only to the year of declaration and its agreed rate.

Preference#2&3: On the same month, the BOD declared cash dividends of P1,200,000. No dividends
were declared for the past two years. Payment month is August.
Preference Ordinary Total
₱ 1,200,000
20,000 shares x 16% x P100 x 3years ₱ 960,000 - 240,000
Remainder to Ordinary share (1.2M -960T) - ₱ 240,000 -
₱ 960,000 ₱ 240,000

Date of Declaration
July Retained Earnings 1 2 0 0 0 0 0
Cash Dividend Payable - Preference 9 6 0 0 0 0
Cash Dividend Payable - Ordinary 2 4 0 0 0 0

Date of Payment
August Cash Dividend Payable - Preference 9 6 0 0 0 0
Cash Dividend Payable - Ordinary 2 4 0 0 0 0
Cash 1 2 0 0 0 0 0

Note: Since preference share is cumulative but non-participating, the preferred shareholders are
entitled to receive dividends not only in the year of declaration but also in the previous years in which

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 72

dividends were not declared. In the example above, preferred shares were given 3 years (1 current +
2 previous years) dividends with its agreed rate.

Preference#3&4 on the same month, the BOD declared cash dividends of 1.2M. No dividends were
declared for the past two years. Payment month is August.
Preference Ordinary Total
₱ 1,200,000
2M x 16% x 3 years ₱ 960,000 240,000
500,000 x 16% x 1 year 80,000 160,000
Remainder to Ordinary share (1.2M -960T) -
Preference (2M /2.5M ) x P160,000 128,000 32,000
Ordinary (2M /2.5M ) x P160,000 - 32,000 -
Total ₱ 1,088,000 ₱ 112,000

Date of Declaration
July Retained Earnings 1 2 0 0 0 0 0
Cash Dividend Payable - Preference 1 0 8 8 0 0 0
Cash Dividend Payable - Ordinary 1 1 2 0 0 0

Date of Payment
August Cash Dividend Payable - Preference 9 6 0 0 0 0
Cash Dividend Payable - Ordinary 2 4 0 0 0 0
Cash 1 2 0 0 0 0 0

Note: Dividends for preference shares are good for 3 years. Use the same dividend rate to distribute
dividends to the ordinary shares. Remaining amount, if any, is distributed to both preferred and ordinary
using their capital ratio.

Preference#5 on the same month, the BOD declared cash dividends of 1.2M. No dividends were
declared for the past two years. Payment month is August.
Preference Ordinary Total
₱ 1,200,000
2M x 16% x 1 year ₱ 320,000 880,000
500,000 x 16% x 1 year 80,000 800,000
2Mx (20% - 16% = 4%) 80,000 720,000
Remainder to Ordinary share -
(1.2M - 320T P80T - P80T) 720,000 -
Total ₱ 400,000 ₱ 800,000

Note: Compute the dividends for both preferred and ordinary use the Preferred's dividends rate. The
20% participating means you must add 4% to preferred (20% - 16% = 4%) based on preferred
capitalization and give the remainder amount to the ordinary shares.

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 73

Date of Declaration
July Retained Earnings 1 2 0 0 0 0 0
Cash Dividend Payable - Preference 1 0 8 8 0 0 0
Cash Dividend Payable - Ordinary 1 1 2 0 0 0

Date of Payment
August Cash Dividend Payable - Preference 4 0 0 0 0 0
Cash Dividend Payable - Ordinary 8 0 0 0 0 0
Cash 1 2 0 0 0 0 0

Note: In computing dividends for preference share always look out its cumulating, participation and
date of declaration.

STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

The statement of changes in shareholders’ equity is one of the statements required to be included
in the financial reports of a company. This is done to support final balances shown in the statement of
financial position. An illustration of one is hereby made below with the assumption of figures. Please
take note the important line items that should be explicitly included in the report are: Paid in Capital or
Contributed Capital, Unappropriated Retained Earnings, Appropriated Retained Earnings, and Treasury
shares.

DBA Corporation
Statement of Changes in Shareholders' Equity
For the year ended December 31, 2021

Share Share Retained Treasury

Reserv es Total
Capital Premium Earnings Shares
January 01 ₱ 2,000,000 ₱ 500,000 ₱ 2,450,000 - - ₱ 4,950,000
Issuance 400,000 40,000 440,000
Reacquired ( ₱ 500,000) (500,000)
Appropriated for Treasury shares (500,000) 500,000 -
Unrealized Gain on Land 100,000 100,000
Net Income 650,000 650,000
Dividends (1,200,000) (1,200,000)
December 31 ₱ 2,400,000 ₱ 540,000 ₱ 1,400,000 ₱ 600,000 ( ₱ 500,000) ₱ 4,440,000

Paid in Capital Unappropriated Treasury

Retained Earnings Appropriated shares
RE

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 74

BOOK VALUE PER SHARE

It is the equity or right of every shareholder in the net assets of the company. Also, it is the amount
that would be paid to the shareholders in the event of liquidation.
Assume the following data for DBA Corporation for the current year.

Assets ₱ 8,760,000
Liabilities 1,310,000
Ordinary shares, P50 par value;
100,000 shares issued and outstanding 5,000,000
Retained Earnings 2,450,000

BVPS computation with one kind of shares

Book Value per Share = Net Assets or Shareholders' Equity

Number of Shares Outstanding
= ₱8,760,000 - ₱1,310,000
100,000 shares
= ₱74.50
Note: Shareholders are entitled of P74.50 for every share they held over the net assets of P7,450,000 in
the event the company cease its operations.

EARNING PER SHARE

It is a relevant information for ordinary shareholders in assessing attractiveness of stock. EPS is the
amount income earned for each share held by the shareholders.
Assume the following data for DBA Corporation:

Ordinary shares, P50 par value;

100,000 shares issued and outstanding ₱ 5,000,000
Net Income 2,400,000

EPS computation is

Earnings per Share = Net Income

Ordinary Shares
= ₱2,400,000
100,000 shares
= ₱24.00

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING

 75

Summary of the Lesson

 Corporations complete their accounting cycle in a manner similar to that of a single proprietorship
or a partnership, except that the resulting balance of Income Summary in the closing process is
transferred to Retained Earnings.
 Restriction on retained earnings is done to accommodate appropriation for treasury share and other
contingent activities of the company.
 There are two kinds of dividends
 Ordinary dividends are dividends out of earnings that can be distributed as:
 Cash dividends, which are distribution of cash to the shareholders;
 Property dividends, which are distribution of non-cash assets to the shareholders;
 Liability/Scrip, where promissory notes are distributed to shareholders; and
 Stock dividends, also known as bonus issue, where shares of the company’s stocks are distributed to
shareholders.
 Liquidating dividends are dividends out of Capital.
 Distributions of dividends to shareholders are made in proportion to the number shares held by the
latter. Except for liquidating dividends, dividends are distributions of corporate profits to shareholders
and this would be charged to retained earnings.
 Allocation of cash dividends between preferred and ordinary shares depends on the class of
preference shares that the corporation issues. Preference shares may be either cumulative or non-
cumulative and either participating or non-participating.
 Statement of Shareholders’ Equity illustrated important line items such as amount for Paid in Capital,
Unappropriated and Appropriated Retained Earnings and Treasury Shares in support to statement
of financial position.
 Book value per share and Earnings per share are relevant information for shareholders in assessing
attractiveness of stock. It’s a shareholders’ right to know the value of each share they held against
the Net Assets and Net Income respectively.

Learning Module on PAC101 – PARTNERSHIP AND CORPORATION ACCOUNTING