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Accounting Principles

Thirteenth Edition
Weygandt Kimmel Kieso

Chapter 14
Corporations: Dividends, Retained
Earnings, and Income Reporting
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
Chapter Outline
Learning Objectives
LO 1 Explain how to account for cash dividends, stock
dividends, and stock splits.
LO 2 Discuss how stockholders’ equity is reported and
analyzed.
LO 3 Describe the form and content of corporation
income statements.

Copyright ©2018 John Wiley & Son, Inc. 2


Accounting for Dividends and Stock
Splits
Distribution of cash or stock to stockholders on a pro rata
(proportional to ownership) basis.
Types of Dividends:
1. Cash
2. Property
3. Stock
4. Scrip (promissory note)

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Cash Dividends
For a corporation to pay a cash dividend, it must have:
1. Retained earnings - Payment of cash dividends from
retained earnings is legal in all states
2. Adequate cash
3. A declaration of dividends by Board of Directors

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Cash Dividends
Three dates are important: ILLUSTRATION 14.1
Key dividend dates

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Cash Dividends
Illustration: On December 1, the directors of Media General
declare a 50 cents per share cash dividend on 100,000 shares
of $10 par value common stock. The dividend is payable on
January 20 to shareholders of record on December 22.
Dec. 1 Cash Dividends 50,000
Dividends Payable 50,000
Dec. 22 No entry
Jan. 20 Dividends Payable 50,000
Cash 50,000

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Dividend Preferences
• Right to receive dividends before common
stockholders
• Per share dividend amount is stated as a percentage
of preferred stock’s par value or as a specified
amount
• Cumulative Dividend Preferred stockholders must be
paid both current-year dividends and any unpaid
prior-year dividends before common stockholders
receive dividends

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Dividend Preferences
Cumulative Dividend
Illustration: Scientific Leasing has 5,000 shares of 7%, $100
par value, cumulative preferred stock outstanding. Each $100
share pays a $7 dividend (.07 × $100). The annual dividend is
$35,000 (5,000 × $7 per share). If dividends are two years in
arrears, preferred stockholders are entitled to receive the
following dividends.
Dividends in arrears ($35,000 × 2) $ 70,000
Current-year dividends 35,000
Total preferred dividends $105,000

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Dividend Preferences
Allocating Cash Dividends Between Preferred and
Common Stock
Holders of cumulative preferred stock must be paid any
unpaid prior-year dividends and their current year’s dividend
before common stockholders receive dividends.

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Allocating Cash Dividends
Illustration: On December 31, 2020, IBR Inc. has 1,000 shares
of 8%, $100 par value cumulative preferred stock. It also has
50,000 shares of $10 par value common stock outstanding. At
December 31, 2020, the directors declare a $6,000 cash
dividend. Calculate the annual preferred dividend.
$100 par x 8% x 1,000 shares = $8,000

Prepare the entry to record the declaration of the dividend.


Dec. 31 Cash Dividends 6,000
Dividends Payable 6,000

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Allocating Cash Dividends
Illustration: At December 31, 2021, IBR declares a $50,000
cash dividend. Show the allocation of dividends to each class
of stock.

Total dividend $50,000


Allocated to preferred stock
Dividends in arrears, 2020 (1,000 × $2) $2,000
2021 dividend (1,000 × $8) 8,000 10,000
Remainder allocated to common stock $40,000

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Allocating Cash Dividends
Illustration: At December 31, 2021, IBR declares a $50,000
cash dividend. Prepare the entry to record the declaration of
the dividend.
Dec. 31 Cash Dividends 50,000
Dividends Payable 50,000

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DO IT! 1a Dividends on Preferred and
Common Stock
MasterMind Corporation has 2,000 shares of 6%, $100 par value
preferred stock outstanding at December 31, 2020. At December
31, 2020, the company declared a $60,000 cash dividend.
Determine the dividend paid to preferred stockholders and
common stockholders under each of the following scenarios.
1. The preferred stock is noncumulative, and the company has
not missed any dividends in previous years.
Preferred stockholders are paid only this year’s dividend
Preferred stockholders = $12,000 (2,000 x .06 x $100)
Common stockholders = $48,000 ($60,000 - $12,000)
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DO IT! 1a Dividends on Preferred and
Common Stock
MasterMind Corporation has 2,000 shares of 6%, $100 par value
preferred stock outstanding at December 31, 2020. At December
31, 2020, the company declared a $60,000 cash dividend.
Determine the dividend paid to preferred stockholders and
common stockholders under each of the following scenarios.
2. The preferred stock is noncumulative, and the company did
not pay a dividend in each of the two previous years.
Past unpaid dividends do not have to be paid
Preferred stockholders = $12,000 (2,000 x .06 x $100)
Common stockholders = $48,000 ($60,000 - $12,000)
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DO IT! 1a Dividends on Preferred and
Common Stock
MasterMind Corporation has 2,000 shares of 6%, $100 par value
preferred stock outstanding at December 31, 2020. At December
31, 2020, the company declared a $60,000 cash dividend.
Determine the dividend paid to preferred stockholders and
common stockholders under each of the following scenarios.
3. The preferred stock is cumulative, and the company did not
pay a dividend in each of the two previous years.
Dividends that have been missed (arrears) must be paid
Preferred stockholders = $36,000 (3 x 2,000 x .06 x $100)
Common stockholders = $24,000 ($60,000 - $36,000)
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Stock Dividends
A pro rata (proportional to ownership) distribution of the
corporation’s own stock to stockholders.
Reasons why corporations issue stock dividends:
1. Satisfy stockholders’ dividend expectations without
spending cash
2. Increase marketability of corporation’s stock
3. Emphasize a portion of stockholders’ equity has
been permanently reinvested in business

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Stock Dividends
• Small stock dividend (less than 20–25% of
corporation’s issued stock, recorded at fair market
value)
 Accounting based on assumption that a small
stock dividend will have little effect on market
price of outstanding shares
• Large stock dividend (greater than 20–25% of issued
stock, recorded at par value)

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Entries for Stock Dividends
Illustration: Medland Corporation declares a 10% stock dividend on
its 50,000 shares of $10 par value common stock. The current fair
market value of its stock is $15 per share. Record the entry on the
declaration date:
Stock Dividends 75,000
Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par—Common Stock 25,000

Paid-in capital
Common stock $500,000
Common stock dividends distributable 50,000
In excess of par—common stock 25,000
Total paid-in capital $575,000
ILLUSTRATION 14.4
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Entries for Stock Dividends
Illustration: Medland Corporation declares a 10% stock dividend on
its 50,000 shares of $10 par value common stock. The current fair
market value of its stock is $15 per share. Record the entry on the
declaration date:
Stock Dividends 75,000
Common Stock Dividends Distributable 50,000
Paid-in Capital in Excess of Par—Common Stock 25,000

Record the journal entry when Medland issues the dividend shares.
Common Stock Dividends Distributable 50,000
Common Stock 50,000

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Effects of Stock Dividends ILLUSTRATION 14.5

Before After
Dividend Change Dividend
Stockholders’ equity
Paid-in capital
Common stock, $10 par $500,000 $ 50,000 $550,000
Paid-in capital in excess of par— 25,000 25,000
Total paid-in capital 500,000 +75,000 575,000
Retained earnings 300,000 -75,000 225,000
Total stockholders’ equity $800,000 $ 0 $800,000
Outstanding shares 50,000 +5,000 55,000
Par value per share $10.00 $0 $10.00

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Stock Dividends
Which of the following statements about small stock
dividends is true?
a. A debit to Retained Earnings should be made for
the par value of the shares issued.
b. A small stock dividend decreases total
stockholders’ equity.
c. Market price per share should be assigned to the
dividend shares.
d. A small stock dividend ordinarily will have an
effect on par value per share of stock.

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Stock Splits
• Issuance of additional shares to stockholders
according to their percentage ownership
• Reduction in par or stated value per share
• Increase in number of shares outstanding
• Reduces market value of shares
• No journal entry recorded, no affect on any balance
in stockholders’ equity

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Stock Splits
Effect of 4-for-1 stock split for stockholders
ILLUSTRATION 14.6

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Effects for Medland Corporation, assuming that it splits its
50,000 shares of common stock on a 2-for-1 basis.
Before After
Dividend Change Dividend
Stockholders’ equity
Paid-in capital
Common stock $500,000 $500,000
Paid-in capital in excess of par— 0
Total paid-in capital 500,000 $ 0 500,000
Retained earnings 300,000 0 300,000
Total stockholders’ equity $800,000 $ 0 $800,000
Outstanding shares 50,000 +50,000 100,000
Par value per share $10.00 -$5.00 $5.00
ILLUSTRATION 14.7
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DO IT! 1b Stock Dividends and Splits
Sing CD Company has had five years of record earnings. Due to this
success, the market price of its 500,000 shares of $2 par value
common stock has tripled from $15 per share to $45. During this
period, paid-in capital remained the same at $2,000,000. Retained
earnings increased from $1,500,000 to $10,000,000. President Joan
Elbert is considering either a 10% stock dividend or a 2-for-1 stock
split. She asks you to show the before-and-after effects of each
option on retained earnings, total stockholders’ equity, shares
outstanding, and par value per share.

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DO IT! 1b Stock Dividends and Splits
Sing CD Company has had five years of record earnings. Due to this
success, the market price of its 500,000 shares of $2 par value
common stock has tripled from $15 per share to $45. President
Joan Elbert is considering either a 10% stock dividend or a 2-for-1
stock split.
Original After After
Balances Dividend Split
Paid-in capital $2,000,000 $4,250,000 $2,000,000
Retained earnings 10,000,000 7,750,000 10,000,000
Total stockholders’ equity $12,000,000 $12,000,000 $12,000,000
Outstanding shares 500,000 550,000 1,000,000
Par value per share $2.00 $2.00 $1.00

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Reporting Stockholders’ Equity
Retained earnings is net income that a company retains
in the business.
• Part of stockholders’ claim on total assets of
corporation
• Debit balance is identified as a deficit
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital
Common stock $800,000
ILLUSTRATION 14.10
Retained earnings (deficit) (50,000)
Stockholders’ equity
with deficit
Total stockholders’ equity $750,000
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Retained Earnings Restrictions
Restrictions can result from:
1. Legal restrictions
2. Contractual restrictions
3. Voluntary restrictions ILLUSTRATION 14.11
Disclosure of restriction

Tektronix Inc.
Notes to the Financial Statements
Certain of the Company’s debt agreements require compliance with debt
covenants. Management believes that the Company is in compliance with such
requirements. The Company had unrestricted retained earnings of $223.8 million
after meeting those requirements.

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Retained Earnings
Prior Period Adjustments
• Correction of an error in previously issued financial
statements
• Result from:
 mathematical mistakes
 mistakes in application of accounting principles
 oversight or misuse of facts

• Adjustment made to beginning balance of retained


earnings
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Retained Earnings
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2020
Balance, January 1 1,050,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $1,110,000

Before issuing the report for the year ended December 31, 2020, you
discover a $50,000 error (net of tax) that caused the 2019 inventory to be
overstated (overstated inventory caused COGS to be lower and thus net
income to be higher in 2019. Would this discovery have any impact on
the reporting of the Statement of Retained Earnings for 2020?

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Retained Earnings
Woods, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2020
Balance, January 1, as reported $1,050,000
Prior period adjustment – error correction (50,000)
Balance, January 1, as restated 1,000,000
Net income 360,000
Dividends (300,000)
Balance, December 31 $1,160,000
Journal entry
Retained Earnings 50,000
Inventory 50,000
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Retained Earnings Statement
Debits and Credits to Retained Earnings

Retained Earnings
1. Net loss 1. Net income
2. Prior period adjustment for 2. Prior period adjustment for
overstatement of net understatement of net
income income
3. Cash dividends and stock
dividends
4. Some disposals of treasury
stock
ILLUSTRATION 14.13

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Graber Inc. ILLUSTRATION 14.14
Balance Sheet (partial)
Stockholders’ equity
Paid-in capital
Capital stock
9% Preferred stock, $100 par value, cumulative,
callable at $120, 10,000 shares authorized,
6,000 shares issued and outstanding $ 600,000
Common stock, no par, $5 stated value,
500,000 shares authorized, 400,000 shares
issued and 390,000 shares outstanding $2,000,000
Common stock dividends distributable 50,000 2,050,000
Total capital stock 2,650,000
Additional paid-in capital
In excess of par—preferred stock 30,000
In excess of stated value—common stock 1,050,000
Total additional paid-in capital 1,080,000
Total paid-in capital 3,730,000
Retained earnings (see Note R) 1,150,000
Total paid-in capital and retained earnings 4,880,000
Less: Treasury stock (10,000 common shares) 80,000
Total stockholders’ equity $4,800,000

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Analysis of Stockholders’ Equity
Payout Ratio
• Measures percentage of earnings a company distributes in
form of cash dividends to common stockholders
To illustrate, Nike’s dividends were recently $821 million and net
income was $2,693 million.

Cash Dividends Net Payout


÷ =
Declared on Common Stock Income Ratio
$821 ÷ $2,693 = 30.5%
ILLUSTRATION 14.15

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Analysis of Stockholders’ Equity
Return on Common Stockholders’ Equity
• Indicates how many dollars of net income company earned for
each dollar invested by common stockholders
Walt Disney Company’s beginning and ending common
stockholders’ equity were $31,820 and $30,753 million,
respectively. Net income was $4,687 million, no preferred stock.

Average Common Return on Common


Net Income minus
÷ Stockholders’ = Stockholders’
Preferred Dividends
Equity Equity
($31,820 + $30,753)
($4,687 - $0) ÷ = 15.0%
2
ILLUSTRATION 14.17

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DO IT! 2 Analyzing Stockholders’
Equity
On January 1, 2020, Siena Corporation purchased 2,000 shares of
treasury stock. Other information regarding Siena Corporation is
provided below.
2019 2020
Net income $110,000 $110,000
Dividends on preferred stock 10,000 10,000
Dividends on common stock 2,000 1,600
Common stockholders’ equity, beginning of year 500,000 400,000*
Common stockholders’ equity, ending of year 500,000 400,000
*Adjusted for purchase of treasury stock.

Compute return on common stockholders’ equity for each year.

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DO IT! 2 Analyzing Stockholders’
Equity 2019 2020
Net income $110,000 $110,000
Dividends on preferred stock 10,000 10,000
Dividends on common stock 2,000 1,600
Common stockholders’ equity, beginning of year 500,000 400,000*
Common stockholders’ equity, ending of year 500,000 400,000
*Adjusted for purchase of treasury stock.
Compute return on common stockholders’ equity for each year.
2019 2020
($110,000 – $10,000) ($110,000 – $10,000)
= 20% = 25%
($500,000 + $500,000)/2 ($400,000 + $400,000)/2

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Income Leads Inc.
Income Statement
Statement For the Year Ended December 31, 2020
Presentation Sales revenue $800,000
Cost of goods sold 600,000
Gross profit 200,000
Operating expenses 50,000
Income from operations 150,000
Other revenues and gains 10,000
Other expenses and losses (4,000)
Income before income taxes 156,000
ILLUSTRATION 14.18 Income tax expense 46,800
Income statement with
income taxes Net income $109,200

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Income Statement Presentation
Companies record income tax expense and the related liability for
income taxes payable as part of the adjusting process.
Using the data for Leads Inc., in Illustration 14.18, the adjusting
entry for income tax expense at December 31, 2020, is as follows.:

Income Tax Expense 46,800


Income Taxes Payable 46,800

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Income Statement Analysis
EPS and Preferred Dividends
• Indicates the net income earned by each share of
outstanding common stock
To illustrate, assume that Rally Inc. reports net income of
$211,000 on its 102,500 weighted-average common shares.
During the year, it also declares a $6,000 dividend on its
preferred stock. Therefore, the amount Rally has available for
common stock dividends is $205,000 ($211,000 − $6,000).
Earnings per share is calculated as follows.

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Income Statement Analysis
To illustrate, assume that Rally Inc. reports net income of
$211,000 on its 102,500 weighted-average common shares.
During the year, it also declares a $6,000 dividend on its
preferred stock. Therefore, the amount Rally has available for
common stock dividends is $205,000 ($211,000 − $6,000).
Earnings per share is calculated as follows.

Weighted-Average
Net Income minus Earnings
÷ Common =
Preferred Dividends per Share
Shares Outstanding

$211,000 - $6,000 ÷ $102,500 = $2.00

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DO IT! 3 EPS
On January 1, 2020, Siena Corporation purchased 2,000 shares of
treasury stock. Other information regarding Siena Corporation is
provided below.
2019 2020
Net income $110,000 $110,000
Dividends on preferred stock 10,000 10,000
Dividends on common stock 2,000 1,600
Weighted-average number of shares outstanding 10,000 8,000*
Common stockholders’ equity, beginning of year 500,000 400,000*
Common stockholders’ equity, ending of year 500,000 400,000
*Adjusted for purchase of treasury stock.

Compute earnings per share for each year.

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DO IT! 3 EPS 2019 2020
Net income $110,000 $110,000
Dividends on preferred stock 10,000 10,000
Dividends on common stock 2,000 1,600
Weighted-average number of shares outstanding 10,000 8,000*
Common stockholders’ equity, beginning of year 500,000 400,000*
Common stockholders’ equity, ending of year 500,000 400,000
*Adjusted for purchase of treasury stock.

Compute earnings per share for each year.


2019 2020
($110,000 – $10,000) ($110,000 – $10,000)
= $10 = $12.50
$10,000 $8,000

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Appendix 14A Stockholders’ Equity
Hampton Corporation ILLUSTRATION 14A.1
Stockholders’ Equity Statement
For the Year Ended December 31, 2020
Common Paid-in Capital
Stock in Excess of Retained Treasury
($5 par) Par-Common Earnings Stock Total
Balance, January 1 $300,000 $200,000 $650,000 $(34,000) $1,116,000
Issued 5,000 shares of
common stock at $15 25,000 50,000 75,000
Declared a $40,000
cash dividend (40,000) (40,000)
Purchased 2,000 shares
for treasury at $16 (32,000) (32,000)
Net income for year 240,000 240,000
Balance, December 31 $325,000 $250,000 $850,000 $(66,000) $1,359,000

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Appendix 14B Book Value per Share
Represents the equity a common stockholder has in the net
assets of the corporation from owning one share of stock.
If Marlo Corporation has total stockholders’ equity of
$1,500,000 (common stock $1,000,000 and retained earnings
$500,000) and 50,000 shares of common stock outstanding,
book value per share is calculated as follows.

Total Number of
Book Value
Stockholders’ ÷ Common Shares =
per Share
Equity Outstanding
$1,500,000 ÷ 50,000 = $30

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Appendix 14B Book Value per Share
When the company has both preferred and common stock,
the computation of book value per share involves the
following steps.
1. Compute preferred stock equity. The sum of the call price
of preferred stock plus any cumulative dividends in
arrears. If the preferred stock does not have a call price,
the par value of the stock is used.
2. Determine the common stock equity. Subtract the
preferred stock equity from total stockholders’ equity.
3. Determine book value per share. Divide common stock
equity by shares of common stock outstanding.

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Appendix 14B Book Value per Share
Using the stockholders’ equity section of Graber Inc. shown in
Illustration 14.14, assume Graber’s preferred stock is callable
at $120 per share and is cumulative, and that dividends on
Graber’s preferred stock were in arrears for one year, $54,000
(6,000 × $9). The computation of preferred stock equity is as
follows.
Call price (6,000 shares × $120) $720,000
Dividends in arrears (6,000 shares × $9) 54,000
Preferred stock equity $774,000

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Appendix 14B Book Value per Share
Using the stockholders’ equity section of Graber Inc. shown in
Illustration 14.14, assume Graber’s preferred stock is callable
at $120 per share and is cumulative, and that dividends on
Graber’s preferred stock were in arrears for one year, $54,000
(6,000 × $9). The computation of book value is as follows.

Common Number of
Book Value
Stockholders’ ÷ Common Shares =
per Share
Equity Outstanding
$4,800,000 - $774,000 ÷ 390,000 = $10.32

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Appendix 14B Book Value per Share
Book value per share may not equal market price per share.
The correlation between book value and the annual range of a
company’s market price per share is often remote.

Book-Value Market Range


Company (year-end) (for the year)
The Limited, Inc. $13.38 $31.03-$22.89
H. J. Heinz Company $ 7.48 $40.61-$34.53
Cisco Systems $ 3.66 $21.24-$17.01
Wal-Mart Stores, Inc. $12.79 $50.87-$42.31
ILLUSTRATION 14B.4
Book value and market prices compared

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A Look at IFRS
Key Points
Similarities
• The accounting related to prior period adjustment is essentially the
same under IFRS and GAAP.
• The stockholders’ equity section is essentially the same under IFRS
and GAAP. However, terminology used to describe certain
components is often different. These differences are discussed in
Chapter 13.

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A Look at IFRS
Key Points
Similarities
• The income statement using IFRS is called the statement of
comprehensive income. A statement of comprehensive income is
presented in a one- or two-statement format. The single-statement
approach includes all items of income and expense, as well as each
component of other comprehensive income or loss by its individual
characteristic. In the two-statement approach, a traditional income
statement is prepared. It is then followed by a statement of
comprehensive income, which starts with net income or loss and
then adds other comprehensive income or loss items. Regardless of
which approach is reported, income tax expense is required to be
reported.

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A Look at IFRS
Key Points
Similarities
• The computations related to earnings per share are essentially the
same under IFRS and GAAP.
Differences
• The term reserves is used in IFRS to indicate all non–contributed
(non–paid-in) capital. Reserves include retained earnings and other
comprehensive income items, such as revaluation surplus and
unrealized gains or losses on available-for-sale securities.
• IFRS often uses terms such as retained profits or accumulated profit
or loss to describe retained earnings. The term retained earnings is
also often used.

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A Look at IFRS
Key Points
Differences
• Equity is given various descriptions under IFRS, such as shareholders’
equity, owners’ equity, capital and reserves, and shareholders’ funds.

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A Look at IFRS
Looking to the Future
The IASB and the FASB are currently working on a project related to
financial statement presentation. An important part of this study is to
determine whether certain line items, subtotals, and totals should be
clearly defined and required to be displayed in the financial statements.
For example, it is likely that the statement of stockholders’ equity and its
presentation will be examined closely.
Both the IASB and FASB are working toward convergence of any
remaining differences related to earnings per share computations. This
convergence will deal with highly technical changes beyond the scope of
this textbook.

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Copyright
Copyright © 2018 John Wiley & Sons, Inc.
All rights reserved. Reproduction or translation of this work beyond that permitted in
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or from the use of the information contained herein.

Copyright ©2018 John Wiley & Son, Inc. 55