Transactions affecting retained earnings

Appropriation of retained earnings

As mentioned above, retained earnings are the portion of equity that are available for distribution to the shareholders. However, when the company wants to restrict a portion of retained earnings from being distributed as dividends, the company can appropriate retained earnings to separate it from the distributable equity.

Appropriation of retained earnings to restrict it from being distributed creates a general reserve within equity that signals the amount is earmarked for a specific purpose, such as planned capital expenditures or research and development, or a dividend restriction in a loan agreement. No cash or other asset is set aside: the appropriation only reclassifies equity, the planned spending is still recorded through the normal asset and expense accounts, and no cost or loss is ever charged against the appropriated balance.

The journal entry to appropriate retained earnings once it is approved is a simple reclassification from the unappropriated retained earnings to the appropriated retained earnings account.

In contrast, when the appropriation has already served its purpose or if it’s no longer needed, we just need to book a reversal of the above entry:

Cash dividends

Dividends are distributions of profits to shareholders and can be in many different forms. It has the impact of reducing the company’s equity through the distribution of an asset or recognition of a liability. The most common form of dividend is in the form of cash. This is when a company commits to distribute cash to its shareholders and there is enough retained earnings to cover the distribution.

There are three relevant dates in the accounting for dividends:

1. date of declaration
2. date of record
3. date of payment.

Cash dividends: date of declaration

This is the date when the company formally commits to pay the dividend through a resolution. This is also the date when the date of record and date of payment are announced.

During this time, the company already incurs a liability measured as the dividend per share multiplied by the number of shares outstanding at that date. The journal entry is as follows:

For cash dividends, the resulting dividends payable is typically presented as a current liability.

Cash dividends: date of record

This is the date when the final list of shareholders who are entitled to the dividend are finalized. The date of record requires no entry for any type of dividend.

Cash dividends: date of payment

This is the date when the dividend is actually paid. The journal entry is as follows:

Liquidating dividends

These are dividends that are not paid out of retained earnings. Typically they are paid out of the company’s APIC as a form of return of capital to the shareholders especially when the retained earnings are not enough for the dividends.

They can be taken out of the common stock if the company is completely liquidating.

Liquidating dividends: date of declaration

At the date of declaration, the company records the following:

A dividend can be partly liquidating just like in this example above. At the date of payment, the journal entry mirrors the cash dividend payment entry shown earlier - a debit to dividends payable and a credit to cash - since the effect on retained earnings and APIC was already recorded at the date of declaration. As with cash dividends, the date of record requires no separate entry.

Property dividends

This is a type of dividend wherein assets, other than cash, are being distributed to the shareholders.

Property dividends can be in many forms such as distributions to shareholders of inventories or shares in another company, to name a few. The general rule is that the property dividend is measured at the fair value of the asset being distributed at the date of declaration - the asset is remeasured to fair value at that date, with any gain or loss recognized in income, and the dividends payable and retained earnings are recorded at that same fair value.

Under U.S. GAAP, the dividend is measured once, at fair value on the declaration date; the payable is not remeasured at later reporting dates. (IFRS, under IFRIC 17, does remeasure an unpaid payable at each reporting date.)

Property dividends: date of declaration

At the date of declaration, the company records two journal entries: one to revalue the asset to fair value, and one to record the dividends payable against retained earnings. For example, suppose Achievable Co. declares a property dividend of inventory with a carrying amount of $80,000 and a fair value of $100,000 at the date of declaration.

The dividends payable in the second journal entry equals the fair value of the inventories in the first journal entry ($100,000).

The property dividend payable is classified by when it will be settled: it is a current liability if distribution is expected within one year (the usual case), regardless of whether the asset being distributed is current or non-current.

Property dividends: date of payment

The journal entry to record the settlement of the dividends payable:

The asset being distributed has already been remeasured to fair value, with any resulting gain or loss recognized before settlement. Accordingly, at the date of payment, the company derecognizes the dividends payable and the asset being distributed. No additional gain or loss is recognized solely from the settlement of the property dividend.

The dividend itself reduces retained earnings by the asset’s fair value ($100,000 in the example above). Combined with the $20,000 remeasurement gain, which also closes to retained earnings, total shareholders’ equity falls by the inventory’s original carrying amount of $80,000 - not its fair value.

Stock dividends

A stock dividend increases the number of shares held by investors without changing total shareholders’ equity, since it is simply a reclassification from retained earnings to paid-in capital accounts.

There are two types of stock dividends:

1. small stock dividend
2. large stock dividend

Small stock dividends

These are stock dividends that are typically less than 20-25% of the existing shares. There is no definite guidance as to the exact % of stock dividends that is considered as “small” but a small stock dividend is generally assessed as a dividend paid in the reporting entity’s own shares that is not large enough to materially influence the unit market price of the stock. This varies between entities and under different market conditions but a distribution of 20-25% of the previous outstanding shares has been identified by the Codification as an initial basis.

Small stock dividends are recorded at the fair value of the shares.

Example: small stock dividend

AZH Co. issues a 10% stock dividend on their 1,000,000 issued and outstanding shares that has a par value of $1.00. The fair value of the shares of AZH Co. is $1.5 per share. The journal entry to be recorded is as follows:

Account	Debit	Credit	Financial statement element
Retained earnings	150,000		Equity
Common stock dividend distributable		100,000	Equity
APIC - common stock		50,000	Equity
To record small stock dividend

Common stock dividend distributable is a paid-in capital account within stockholders’ equity, not a liability. At the date of distribution, it’s debited and common stock is credited for the same amount, once the new shares are actually issued.

Large stock dividends

Large stock dividends are those that are typically greater than 20-25% of the existing shares. These are recorded at the par value of the issued shares.

For example, if AZH Co. instead issued a 30% stock dividend on its 1,000,000 shares (300,000 new shares) at the $1.00 par value, the $1.50 fair value is ignored and the entry is:

There is no impact on APIC of a large stock dividend.

Stock splits

A stock split increases the number of shares outstanding by proportionally reducing the par value per share - for example, a 2-for-1 split doubles the shares outstanding and halves the par value per share. Unlike a stock dividend, a stock split requires no journal entry: total par value, APIC, retained earnings, and total shareholders’ equity are all unchanged, and only the share count and par value per share change. Contrast this with a large stock dividend, which does require a journal entry reclassifying retained earnings into paid-in capital.