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Financial and Managerial Accounting: The Basis for Business Decisions, 12/e
Jan R. Williams, University of Tennessee
Susan F. Haka, Michigan State University
Mark S. Bettner, Bucknell University
Robert F. Meigs

Income and Changes in Retained Earnings

Chapter Summary

Chapter 12 - Summary

LO 1

Describe how discontinued operations, extraordinary items, and accounting changes are presented in the income statement.

Each of these irregular items is shown in a separate section of the income statement, after determination of the income or loss from ordinary and continuing operations. Each special item is shown net of any related income tax effects.

LO 2

Compute earnings per share.

Net earnings per share is computed by dividing the income applicable to the common stock by the weighted-average number of common shares outstanding. If the income statement includes subtotals for income from continuing operations, or for income before extraordinary items, per-share figures are shown for these amounts, as well as for net income.

LO 3

Distinguish between basic and diluted earnings per share.

Diluted earnings per share is computed only for companies that have outstanding securities convertible into shares of common stock. In such situations, the computation of basic earnings per share is based on the number of common shares actually outstanding during the year. The computation of diluted earnings per share, however, is based on the potential number of common shares outstanding if the various securities were converted into common shares. The purpose of showing diluted earnings is to warn investors of the extent to which conversions of securities could reduce basic earnings per share.

LO 4

Account for cash dividends and stock dividends, and explain the effects of these transactions on a company's financial statements.

Cash dividends reduce retained earnings at the time the company's board of directors declares the dividends. At that time, the dividends become a liability for the company. Stock dividends generally are recorded by transferring the market value of the additional shares to be issued from retained earnings to the appropriate paid-in capital accounts. Stock dividends increase the number of shares outstanding but do not change total stockholders' equity.

LO 5

Describe and prepare a statement of retained earnings.

A statement of retained earnings shows the changes in the balance of the Retained Earnings account during the period. In its simplest form, this financial statement shows the beginning balance of retained earnings, adds the net income for the period, subtracts any dividends declared, and thus computes the ending balance of retained earnings. Any prior period adjustments also are shown in this financial statement.

LO 6

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

A prior period adjustment corrects errors in the amount of net income reported in a prior year. Because the income of the prior year has already been closed into retained earnings, the error is corrected by debiting or crediting the Retained Earnings account. Prior period adjustments appear in the statement of retained earnings as adjustments to beginning retained earnings. They are not reported in the income statement for the current period.

LO 7

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

Net income is a component of comprehensive income. As the term implies, comprehensive income is broad and includes the effect of certain transactions that are recognized in the financial statements but that are not included in net income because they have not yet been realized. An example is the change in market value of available-for-sale investments. Net income is presented in the income statement. Comprehensive income may be presented in a combined statement with net income, in a separate statement of comprehensive income, or as a part of the statement of stockholders' equity.

LO 8

Describe and prepare a statement of stockholders' equity.

This expanded version of the statement of retained earnings explains the changes during the year in each stockholders' equity account. It is not a required financial statement but is often prepared instead of a statement of retained earnings. The statement lists the beginning balance in each stockholders' equity account, explains the nature and the amount of each change, and computes the ending balance in each equity account.