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Companies: Retained Profits,
Share Splits and Buy-backs and the Statement of
Financial Performance
Chapter 15
HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT
15 - 2Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objectives
1.Account for share dividends.
2.Distinguish share splits from share dividends.
3.Account for share buy-backs.
4.Report transfer to reserves.
5.Identify the elements of a company’s statement of financial performance.
6.Calculate earnings per share.
15 - 3Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Retained Profitsand Dividends
Retained Profits shows the amount of profits allowed to accumulate from the beginning of the company’s life to the present.
Retained Profits represents a claim on assets, but it is not cash.
15 - 4Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Retained Profitsand Dividends
The balance in the Profit and Loss Summary account is closed to Retained Profits at period end.
Dividends are distributions to the shareholders.
To declare dividends there must be adequate retained profits.
15 - 5Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objective 1
Account for share dividends.
15 - 6Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Share Dividends
What are shares dividends? They are a proportional distribution of a
company’s own shares to shareholders. They do not change total shareholders’
equity. A share dividend is a transfer of
retained profits to contributed equity.
15 - 7Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Reasons for a Share Dividend
To continue dividends but conserve cash
To reduce the market price of shares:How ?Why ?
15 - 8Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Recording Shares Dividend
Same sequence as cash dividends Assume Perth Limited declared a
dividend of $1 per share for 90,000 shares.
What are the entries when the dividend is declared and distributed?
What are the entries when the dividend is declared and distributed?
15 - 9Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Shares Dividend Example
Retained Profits 90,000Dividend payable90,000
To declare an ordinary share dividend from retained profits
Retained Profits 90,000Dividend payable90,000
To declare an ordinary share dividend from retained profits
Dividend Payable 90,000Ordinary Share Capital90,000
To issue 90,000 ordinary share in a share dividend
Dividend Payable 90,000Ordinary Share Capital90,000
To issue 90,000 ordinary share in a share dividend
15 - 10Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Shares Split
This is an increase in the number of shares.
The market value is usually reduced proportionately.
15 - 11Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Shares Split
A 5-for-1 Shares split means that the company would have five times as many issued shares after the split as it had before.
Each share’s market value would be divided by (almost or about) five.
15 - 12Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Shares Split Example
Prior to a 5-for-1 split, Adelaide had 500,000 shares with a market price of approximately $10.
After the split, 2,500,000 shares are issued.
What is the approximate market value per share?
$10 ÷ 5 = $2
15 - 13Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objective 2
Distinguish share splitsfrom share dividends.
15 - 14Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Similarities Between ShareSplits and Share Dividends
Both increase the number of sharesowned per shareholder.
Both increase the number of sharesowned per shareholder.
Neither change the investor’scost of the shares they own. Neither change the investor’scost of the shares they own.
Neither creates taxable income for the shareholder.
Neither creates taxable income for the shareholder.
15 - 15Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Differences Between ShareSplits and Share Dividends
A Shares dividend shifts an amount from retained profits to share capital.
A Shares split affects no account balance. Both increases the number of issued
shares Both usually decrease the market price of
each share.
15 - 16Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objective 3
Account for share buy-backs.
15 - 17Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Shares Buy-backs.
Purchasing your own shares decreases assets and shareholders’ equity.
15 - 18Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Share Buy-back Example
Melbourne Limited purchased 1,000 of its own ordinary shares for $20 per share.
Share Capital 20,000Cash 20,000
To buy back 1,000 ordinary shares
Share Capital 20,000Cash 20,000
To buy back 1,000 ordinary shares
15 - 19Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Share Buy-back Example
Share Capital(Before buy-back of ordinary shares)
Share Capital(Before buy-back of ordinary shares)
Share Capital 50,000 ordinary shares (issued for $4) $200,000
Retained profits 50,000
Total Shareholders’ equity $250,000
Share Capital 50,000 ordinary shares (issued for $4) $200,000
Retained profits 50,000
Total Shareholders’ equity $250,000
15 - 20Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Share Buy-back Example
(After buy-back of ordinary shares)(After buy-back of ordinary shares)
Share Capital 49,000 ordinary shares $180,000
Retained profits 50,000
Total Shareholders’ equity $230,000
Share Capital 49,000 ordinary shares $180,000
Retained profits 50,000
Total Shareholders’ equity $230,000
15 - 21Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Share Buy-back
No gain or loss is recognised on the buy-back of shares.
Accounting standards in Australia simply require the share buy-back to be debited against shareholders’ equity
Retained profits could be debited but rarely is.
Tax implications of share buy-backs is important (capital gain or dividend?).
15 - 22Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
The Statement of Financial Performance
(Continuing Operations)
Allied Electronics LtdStatement of Financial Performance
Year Ended December 31, 2005(see exhibit 15-2 page 611 of your textbook)
Net sales revenue $500,000Cost of goods sold 240,000Gross profit 260,000Operating expenses (175,000)Borrowing costs expense (10,000)
Profit from ordinary activity before tax 75,000
15 - 23Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objective 4
Report transfers to reserves
15 - 24Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Retained Profits
Appropriations are transfers (by a formal journal entry) of retained profits.
A company may appropriate – segregate in a separate account a portion of retained profit for a specific use or as a general reserve.
An appropriation does not decrease total retained profits.
But a reserve is not cash or funds.
15 - 25Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objective 5
Identify the elements of acompany’s statement offinancial performance.
15 - 26Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
The Statement of Financial Performance
(Continuing Operations)
Allied Electronics LtdStatement of Financial Performance
Year Ended December 31, 2005(see exhibit 15-2 page 611 of your textbook)
Net sales revenue $500,000Cost of goods sold 240,000Gross profit 260,000Operating expenses (175,000)Borrowing costs expense (10,000)
Profit from ordinary activity before tax 75,000
15 - 27Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
(Continuing Operations)
Profit (from previous page) 75,000Income tax expense (30,000)Profits from Ord. Act. after tax 45,000
Extraordinary flood loss (15,000)Less income tax saving 6,000 (9,000)
Net profit 36,000
Earnings per share $1.20
Note: Significant (abnormal) item……
15 - 28Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Analysing the Quality of Earnings
Net profit is probably the most important piece of information about a company.
Two aspects are critical:Trend of a company’s earnings andMakeup of a company’s earnings.
AASB 1018 and IAS 1 prescribe the separation of continuing operations from discontinuing operations – see exhibit 15-2
15 - 29Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Analysing the Quality of Earnings
The accounting standards also require details to be disclosed in a note to the accounts when a revenue or expense is of such a size or nature, that it is relevant in explaining the financial performance.
Called significant or abnormal items. May include large inventory write downs
or retrenchment payouts etc.
15 - 30Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Analysing the Quality of Earnings
Extraordinary items are both unusual and infrequent.
They are outside the ordinary operations of the business.
They are reported along with their income tax effect.
15 - 31Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Analysing the Quality of Earnings
Extraordinary items include expropriations. Also, they include losses due to natural
disasters. cyclones flood fire
15 - 32Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Analysing the Quality of Earnings
AASB 1018 requires that the statement of financial performance report an all-inclusive or comprehensive profit figure.
Prior period adjustments therefore need to be included in current profits.
Significant adjustments will need separate disclosure – usually in the notes.
15 - 33Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Analysing the Quality of Earnings
AASB 1040 Statement of Financial Position and IAS 1 Presentation of Financial Statements require retained profits to be disclosed separately.
Changes in retained profits are normally set out in the notes to the financial statements.
See exhibit 15-3 page 614 of your textbook
15 - 34Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Objective 6
Calculate earnings per share.
15 - 35Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Earnings Per Share Example
On January 1, Sydney Limited had 100,000 ordinary shares outstanding.
On May 31, the company re-purchased 40,000 shares.
On September 1, they issued 30,000 new ordinary shares.
Profit for the year was $135,000. What are the earnings per share?
15 - 36Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
No. of Shares Fraction WeightedOutstanding of Year Average
100,000 × 151/365 = 41,370 60,000 × 92/365 = 15,123135,000 × 122/365 = 30,082Total 86,575
EPS = profits after tax minus preference dividends ÷ 86,575
Earnings Per Share Example
15 - 37Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Earnings Per Shareand Preferred Shares
Company’s with complex capital structures present two sets of EPS amounts.
1 EPS based on ordinary shares issued (basic EPS)
2 EPS based on ordinary shares issued plus the number of additional ordinary shares that would arise from conversion of the preference shares (diluted EPS)
15 - 38Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Reporting Other ItemsAffecting Equity
Many companies are required to report changes in:Asset Revaluation ReserveExchange differencesChanges in retained profits due to the
adoption of new accounting standards.
15 - 39Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
Statement of FinancialPerformance - Example
Net Profits 40,000
Increases (decreases) in asset revaluation reserve 10,000
Net exchange differences on translation of financial reports of foreign operations 2,500
Increase (decrease) in retained profits on adoption of a new Standard (3,000)
Total revenues, expenses and valuation adjustments recognised directly in equity 9,500
Total changes in equity other than those resultingfrom transactions with owners as owners $ 49,000
15 - 40Horngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education AustraliaHorngren ♦ Harrison ♦ Bamber ♦ Best ♦ Fraser ♦ Willett, Accounting 4e Copyright © 2004 Pearson Education Australia
End of Chapter 15