Accounting for changes in shareholder equity.
During the life of a corporation, many changes may occur in the shareholder's equity accounts. The accumulation of income in the retained earnings account and its subsequent distribution are the most frequent changes. There are, however, several others which, although they may occur infrequently, deserve some attention.
The first of these is treasury stock. Treasury stock is defined as "stock which (1) has been issued as fully paid, (2) has later been reacquired by the corporation and (3) has not been canceled or reissued." Treasury stock is recorded as a contra account in the equity section of the balance sheet. The most commonly used method of recording the purchase is the cost basis. The treasury stock account is debited for the actual purchase price at the time of reacquisition. Neither the par nor the original stock price are considered. If the stock is then reissued, any difference between the purchase price and the reissue price is usually applied to the Paid-in Capital account. For example, if a corporation purchases 2,000 shares of its stock at $100 per share and at later dates reissues 500 shares at $120 and 400 shares at $90, the entries would be as shown in Figure 1.
In the second case, where the reissue price is lower, the difference may be debited to the Retained Earnings account as an alternative to a reduction from the Paid-in Capital account.
Stock changes may also occur as a result of stock redemptions. A corporation may have issued preferred stock which includes a contract giving the corporation the right to redeem that stock at a future date. If the redemption price is less than the original issue price, the corporation has in essence retained some of its original capital. The difference between the two prices is credited to the Paid-in Capital account. When the redemption price is greater than the original issue price, the difference is usually considered a distribution of retained earnings.
Balance sheet presentation varies in the use of the Paid-in Capital account. A single amount generally titled "Additional Paid-in Capital" may be shown, or this account may be listed in a detailed fashion, showing the sources of paid-in capital. In either case, significant changes must be disclosed.
The issuance of stock dividends also affects both Paid-in Capital and Retained Earnings. When a stock dividend is issued, no cash is distributed. This allows a corporation to retain earnings for use in capital expansion. It is almost as if the shareholder has used a cash distribution to purchase additional stock. Within the corporation, the effect is a transfer from retained earnings to paid-in capital. Most states require that an amount equivalent to the par or stated value of the dividend be transferred between these two accounts. This treatment is generally considered adequate for non-public corporations.
Cash dividends generally affect only retained earnings. Before a corporation can declare a dividend, it must have not only the cash on hand, but sufficient unappropriated retained earnings as well. When a dividend is declared by the board of directors, it becomes a liability of the corporation and is recorded on that date as an amount payable. No other entries are made until the dividend is paid. The date of record is used only to determine actual stock ownership. If a corporation has issued cumulative preferred stock and is in arrears, the dividends in arrears should be disclosed in a footnote or by segregating retained earnings on the balance sheet.
Although most unusual items are disclosed in the income statement, an exception is made for prior period adjustments due to errors. Material errors discovered in a subsequent period are reported as an adjustment of retained earnings at the beginning of the period in which the adjustment is made (FASB 16). Material errors are infrequent but may result from the omission of year end adjustments and accruals or from mathematical mistakes. The most usual error is incorrect depreciation or amortization. Adjustments to retained earnings are made net of applicable income tax. Figure 2 is an example of balance sheet presentation.
Finally, one additional change may be made in the shareholder's equity accounts which will not alter total equity. A portion of retained earnings may be appropriated for specific purposes. This may be done through action by the board of directors or may be required as the result of a contract. For example, when a corporation issues bonds, the bond agreement may require that a portion of retained earnings be set aside for eventual repayment, or the board of directors may decide that such an appropriation may be beneficial. The appropriation account as discussed here does not involve any asset accounts. It is merely a way of restricting retained earnings and, in that manner, restricting the distribution of dividends. It does not restrict the use of cash in any manner.
The presentation of appropriated retained earnings on the balance sheet may vary. The information may be shown on the face of the balance sheet or may be disclosed in the form of a note. Generally if separate accounts are kept in the ledger for appropriations, the accounts are shown on the balance sheet, including any current year changes. The presentation is shown in Figure 3.
As has been shown, for all of the matters discussed above and for any changes in shareholder equity, there is a variety of correct balance sheet presentations. The most important thing to remember is that changes must be disclosed and must be readily understood by all users of the financial statements.
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|Author:||Schwartz, Marlyn A.|
|Publication:||The National Public Accountant|
|Date:||Aug 1, 1990|
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