Dividend policy theories ppt

advantages and disadvantages of dividend policy and dividend preference theory
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Published Date:26-07-2017
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CHAPTER 15 CORPORATIONS: DIVIDENDS, RETAINED EARNINGS, AND INCOME REPORTING www.ThesisScientist.comDIVIDENDS • A dividend is a distribution by a corporation to its shareholders on a pro rata (equal) basis. • Dividends may be in the form of – Cash – Shares (normally common shares) www.ThesisScientist.comCASH DIVIDENDS • A cash dividend is a pro rata distribution of cash to shareholders. • For a cash dividend to occur, a corporation must have: 1. retained earnings, 2. adequate cash, and 3. declared dividends www.ThesisScientist.comENTRIES FOR CASH DIVIDENDS • Three dates are important in connection with dividends: – Declaration date – Record date – Payment date www.ThesisScientist.comALLOCATING CASH DIVIDENDS BETWEEN PREFERRED AND COMMON SHARES • Cash dividends must first be paid to preferred shareholders before any common shareholders are paid. • When preferred shares are cumulative, any dividends in arrears must be paid to preferred shareholders before allocating any dividends to common shareholders. • When preferred shares are non-cumulative, only the current year’s dividend must be paid to preferred shareholders before paying any dividends to common shareholders. www.ThesisScientist.comSTOCK DIVIDENDS • A stock dividend is a pro rata distribution of the corporation’s own shares to its shareholders. • A stock dividend results in a decrease in retained earnings and an increase in share capital since a portion of retained earnings is transferred to legal capital. • In most cases, the fair market value is assigned to the dividend shares. • Total shareholders’ equity and the legal capital per share remain the same. www.ThesisScientist.comILLUSTRATION 15-4 STOCK DIVIDEND EFFECTS Before After Stock Dividend Stock Dividend Shareholders’ equity 500,000 575,000 Common shares 300,000 225,000 Retained earnings 800,000 800,000 Total shareholders’ equity 50,000 55,000 Issued shares 16.00 14.55 Book value per share Stock dividends change the composition of shareholders’ equity because a portion of retained earnings is transferred to contributed capital. However, total shareholders’ equity remains the same. The number of shares increases and this means that the book value per share decreases. PURPOSES AND BENEFITS OF STOCK DIVIDENDS • For company – To satisfy shareholders' dividend expectations without spending cash – To increase marketability of its shares by increasing number of shares and decreasing market price per share – To reinvest and restrict a portion of shareholders' equity www.ThesisScientist.comPURPOSES AND BENEFITS OF STOCK DIVIDENDS • For shareholder – More shares with which to earn additional dividend income – More shares for future profitable resale, as share price climbs again www.ThesisScientist.comSTOCK SPLITS • A stock split involves the issue of additional shares to shareholders according to their percentage of ownership. • In a stock split, the number of shares is increased in the same proportion that legal capital per share is decreased. • A stock split has no effect on total share (contributed) capital, retained earnings, or shareholders’ equity. • It is not necessary to formally journalize a stock split. www.ThesisScientist.comILLUSTRATION 15-5 STOCK SPLIT EFFECTS A stock split does not affect total share capital, retained earnings, or shareholders’ equity. However, the number of shares increases and book value per share decreases. Before After Stock Split Stock Split Shareholders’ equity 500,000 500,000 Common shares 300,000 300,000 Retained earnings 800,000 800,000 Total shareholders’ equity 50,000 100,000 Issued shares 16.00 8.00 Book value per share www.ThesisScientist.comILLUSTRATION 15-6 EFFECTS OF STOCK SPLITS, STOCK DIVIDENDS, AND CASH DIVIDENDS Stock Stock Cash Split Dividend Dividend Total assets NE NE  Total liabilities NE NE NE Total shareholders’ equity NE NE Total share capital NE NE Total retained earnings NE Legal capital per share NE NE Book value per share Number of shares NE % of shareholder ownership NE NE NE NE = No effect = Increase = DecreaseRETAINED EARNINGS • Retained earnings is the cumulative net earnings (less losses) that is retained in the business (i.e., not distributed to shareholders) Retained earnings, opening balance + Net earnings (or - net loss) - Dividends = Retained earnings, ending balance www.ThesisScientist.comDEFICIT Shareholders’ equity Share capital Common shares 800,000 Retained earnings (deficit) (50,000) Total shareholders’ equity 750,000 A debit balance in retained earnings is identified as a DEFICIT and is reported as a deduction in the shareholders’ equity sectionRETAINED EARNINGS RESTRICTIONS • In some cases there may be retained earnings restrictions that make a portion of the balance currently unavailable for dividends • Restrictions result from one or more of the following causes – Legal – Contractual – Voluntary www.ThesisScientist.comPRIOR PERIOD ADJUSTMENTS • A prior period adjustment results from 1. the correction of a material error in reporting net income in previously issued financial statements, or 2. changing an accounting principle. www.ThesisScientist.comPRIOR PERIOD ADJUSTMENTS • A correction of an error occurs after the books are closed, and relates to a prior accounting period. • A change in an accounting principle occurs when the principle used in the current year is different from the one used in the preceding year. www.ThesisScientist.comPRIOR PERIOD ADJUSTMENTS • The cumulative effect of the correction or change (net of income tax) should be – made directly to Retained Earnings; – reported in the current year’s retained earnings statement as an adjustment of the beginning balance of Retained Earnings; – disclosed in a footnote to the financial statements; – corrected and restated in all prior period financial statements presented; and – the corrected amount or new principle should be used in reporting the results of operations of the current year. www.ThesisScientist.comILLUSTRATION 15-12 DEBITS AND CREDITS TO RETAINED EARNINGS Retained Earnings Debits (Decreases) Credits (Increases) 1. Correction of a prior period 1. Correction of a prior period error that overstated income error that understated 2. Cumulative effect of a income change in accounting 2. Cumulative effect of a principle that decreased change in accounting income principle that increased 3. Net loss income 4. Cash dividends 3. Net income 5. Stock dividends Many corporations prepare a statement of retained earnings to explain the changes in retained earnings during the year. Some companies combine this statement of retained earnings with their income statement.CORPORATION INCOME STATEMENTS • The income statement for a corporation includes essentially the same sections as in a proprietorship or a partnership. • The major difference is a section for income tax expense. • For tax purposes, corporations are considered to be a separate legal entity.

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