companies: retained profits, share splits and buy-backs and the statement of financial performance...

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.


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.


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.


Objective 1

Account for share dividends.


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.


Reasons for a Share Dividend

To continue dividends but conserve cash

To reduce the market price of shares:How ?Why ?


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?


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


Shares Split

This is an increase in the number of shares.

The market value is usually reduced proportionately.


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.


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


Objective 2

Distinguish share splitsfrom share dividends.


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.


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.


Objective 3

Account for share buy-backs.


Shares Buy-backs.

Purchasing your own shares decreases assets and shareholders’ equity.


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



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





(After buy-back of ordinary shares)(After buy-back of ordinary shares)

Share Capital 49,000 ordinary shares $180,000



Share Capital 49,000 ordinary shares $180,000




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?).


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


Objective 4

Report transfers to reserves


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.


Objective 5

Identify the elements of acompany’s statement offinancial performance.


The Statement of Financial Performance


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



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……


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



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.



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.



Extraordinary items include expropriations. Also, they include losses due to natural

disasters. cyclones flood fire



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.



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


Objective 6

Calculate earnings per share.


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?


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


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)


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.


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


End of Chapter 15

companies: retained profits, share splits and buy-backs and the statement of financial performance...

Documents

share dividend slide

ordinary share dividend

share splits

profits dividend payable90

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ordinary share capital90

adequate retained profits

cash dividends