By Vernon White,2014-11-29 17:11
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Chapter Summary

     Chapter 12 continues the coverage of stockholders’ equity but shifts the focus from paid-in capital to retained earnings. The student is already aware that net income drives the changes in retained earnings. However, in any given period net income may reflect unusual and nonrecurring events. We begin by explaining how to define such items and how to present them so that the income statement may still serve as the basis for reasonable estimates of future earnings. The three categories of events, which require special treatment, are (1) discontinued operations, (2) extraordinary items, and (3) changes in accounting principle. Each item is explained and illustrated with a Case in Point capsule based on the experience of an actual company.

     Before turning to the impact of various dividend transactions, we briefly review basic and diluted earnings per share. The emphasis here is on interpretation of the EPS figures, since the detailed mechanics of calculating these measures is beyond the scope of the first course.

     The second major section of the chapter explains a number of stockholder equity transactions that affect retained earnings. The most obvious example of such transactions is the declaration of a cash dividend. The requirements for distributing a cash dividend are outlined as are the significant dates involved in the distribution of the dividend. Stock dividends are discussed since they too result in a reduction in retained earnings. This portion of the chapter closes with a brief explanation of prior period adjustments to retained earnings.

     Additional topics covered in Chapter 12 include an introduction to comprehensive income and a review of the statement of stockholders’ equity.

Learning Objectives

    1. Describe how discontinued operations, extraordinary items, and accounting changes

    are presented in the income statement.

2. Compute earnings per share.

3. Distinguish between basic and diluted earnings per share.

    4. Account for cash dividends and stock dividends, and explain the effects of these

    transactions on a company’s financial statements.

5. Describe and prepare a statement of retained earnings.

6. Define prior period adjustments, and explain how they are presented in financial


    McGraw-Hill/Irwin ? The McGraw-Hill Companies, Inc., 2005 136 Instructor’s Resource Manual

    7. Define comprehensive income, and explain how it differs from net income.

8. Describe and prepare a statement of stockholders’ equity.

     Brief topical outline

     A Reporting the results of operations

     1 Developing predictive information see Management Strategy (page 505)

    2 Reporting irregular items: an illustration

    3 Continuing operations

    a Income from continuing operations

    4 Discontinued operations

    a Discontinued operations are not really unusual see Case in Point

    (page 506)

     5 Extraordinary items see Case in Point (page 507)

     a Other unusual gains and losses

     b Distinguishing between the unusual and the extraordinary

     c Restructuring charges see Case in Point (page 508)

     6 Changes in accounting principle

     a The cumulative effect of an accounting change

     b Changes in principle versus changes in estimate see Your Turn (page


     7 Earnings per share (EPS)

     a Computing earnings per share

     b What happens if more shares are issued?

     c Preferred dividends and earnings per share

     d Presentation of earnings per share in the income statement

     e Interpreting the different per-share amounts

     B Financial analysis see Case in Point (page 512)

     1 Basic and diluted earnings per share see Management Strategy (page 512)

     C Other transactions affecting retained earnings

     1 Cash dividends see Your Turn (page 513)

     2 Dividend dates

     3 Liquidating dividends

     4 Stock dividends

     a Entries to record a stock dividend

     b Reasons for stock dividends see Case in Point (page 516)

     c Distinctions between stock splits and stock dividends

     5 Statement of retained earnings

     6 Prior period adjustments

     a Restrictions of retained earnings

     McGraw-Hill/Irwin ? The McGraw-Hill Companies, Inc., 2005

    Financial and Managerial Accounting: The Basis for Business Decisions, 13e 137

    7 Comprehensive income see Cash Effects (page 520)

    8 Statement of stockholders’ equity

    9 Stockholders’ equity section of the balance sheet

     D Concluding remarks see A Second Look (page 522)

Topical coverage and suggested assignment

    Homework Assignment

    (To Be Completed Prior to Class)

    Class Topical

    Meetings Outline Discussion

    on Chapter Coverage Questions Exercises Problems Cases Internet

    1 A 1, 2, 3, 5 1, 3, 4, 5 1, 3 3, 6 1

    2 B D 9, 10, 14, 16, 18 7, 8, 10, 11 4, 6, 7 4

Comments and observations

Teaching objectives for Chapter 12

In this chapter, we discuss a variety of events and transactions that affect retained earnings. In

    the classroom, our objectives are to:

1 Explain the purpose of reporting irregular events separately from normal and recurring

    business activities.

2 Carefully define discontinued operations, extraordinary items, and accounting

    changes. Review and discuss the financial statement presentation of each category of


    3 Illustrate the computation of earnings per share, and briefly discuss the distinction

    between basic and diluted earnings.

4 Discuss the nature and purpose of cash dividends and stock dividends, emphasizing the

    effects upon total stockholders' equity and the probable effects upon stock price.

    Illustrate the journal entries for each of the events.

    5 Explain the nature of prior period adjustments. Discuss probability of occurrence in

     publicly owned and closely held corporations.

6 Review and discuss the statement of retained earnings.

7 Explain the nature of comprehensive income.

    8 Review the statement of stockholders' equity portrayed as an "expanded" statement of

    retained earnings.

McGraw-Hill/Irwin ? The McGraw-Hill Companies, Inc., 2005