BALIUAG UNIVERSITY

Integrated Accounting Course II

Summer 2017
MODULE 13: Retained Earnings LVC

 RELATED STANDARDS: IAS 1 – Presentation of Financial Statements; IAS 32 – Financial Instruments: Presentation;
IFRIC 17 – Distributions of Non-cash Assets to Owners; Batas Pambansa Bilang 68 – The Corporation Code of the
Philippines ; SEC regulations

 Definition of Terms
Deficit – Accumulated losses resulting in a debit balance of the retained earnings.
Dividends – Distribution of earnings or capital to shareholders as declared by the board of directors.
Quasi Reorganization – The procedure of restating assets, liabilities and share capital balances in conformity with fair
value for the purpose of eliminating deficit.
Retained earnings – Cumulative balance of periodic earnings, dividend distributions, prior period adjustments and other
capital adjustments.

 Retained Earnings
a. Unappropriated retained earnings
 The free portion which can be declared as dividends.
b. Appropriated retained earnings
 The restricted portion which is not available for dividend declaration.
Part 1: Dividends
 Dividends
 Classification according to source of dividends
a. Dividends out of earnings
 Dividends declared out of retained earnings
 SEC ruled that stock dividends may be declared from premium on par value shares
b. Dividend out of capital
 Liquidating dividends
 Classification according to forms of dividends
1. Cash dividends
2. Property dividends
3. Liability dividends
4. Stock dividends
 Recognition of dividend
 Dates relating to dividend
1. Date of declaration – The date when the BOD authorized the payment of dividends.
2. Date of record – Shareholders registered as of this date are entitled to dividends.
3. Date of payment – Date when the dividend liability is paid.
 According to IFRIC 17, the liability to pay a dividend shall be recognized when the dividend is appropriately
authorized and is no longer at the discretion of the entity, which is the date:
a. When declaration of the dividend, by management or the board of directors, is approved by the relevant
authority, if the jurisdiction requires such approval, or
b. When the dividend is declared, by management or the board of directors, if the jurisdiction does not require
further approval. (Philippine setting requires no further approval)
 Cash dividends
 Most common type of dividends.
 Create liability account. Retained earnings or a temporary account “Dividends Declared” debited.
 Property dividends
 Measurement of property dividends payable (IFRIC 17)
 An entity shall measure a liability to distribute non-cash assets as a dividend to its owners at the fair value of
the assets to be distributed.
 At the end of each reporting period and at the date of settlement, the entity shall review and adjust the
carrying amount of the dividend payable, with any changes in the carrying amount of the dividend payable
recognized in equity as adjustments to the amount of the distribution.
 Measurement of noncash asset distributed (IFRS 5)
 An entity shall measure a non-current asset (or disposal group) classified as held for distribution to owners at
the lower of its carrying amount and fair value less costs to distribute.

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 At year end, impairment loss is recognized for the difference between carrying amount and fair value less costs.
 Settlement of property dividend payable (IFRIC 17)
 When an entity settles the dividend payable, it shall recognize the difference, if any, between the carrying
amount of the assets distributed and the carrying amount of the dividend payable in profit or loss.
 Gain or loss on distribution of property dividends.
 Choice between cash or noncash dividends
 If an entity gives its owners a choice of receiving either a non-cash asset or a cash alternative, the entity shall
estimate the dividend payable by considering both the fair value of each alternative and the associated probability
of owners selecting each alternative. (IFRIC 17)
 At year and date of settlement, dividend payable is adjusted based on the chosen alternative. Adjustment is
effected through retained earnings.
 When shareholders may elect to receive cash in lieu of stock dividends, the amount charged as dividends is the
optional cash dividend. (Philippine GAAP)
 Liability dividend
 Bond dividend or scrip dividend may be issued to shareholders.
 Accounting for financial liability (PFRS 9 and PAS 32) shall be used to account for the liability dividend issued.
 Stock/Share dividend
 Also called “bonus issue” by IAS
 Accounted using Philippine local GAAP
 Stock dividends payable/Share dividends distributable is classified as a component of equity and not as liability.

 Measurement of stock dividend

a. Large stock dividend
 Stock dividends is 20% or more of the outstanding shares.
 Stock dividend is measured at par
b. Small stock dividend
 Stock dividends is less than 20% of the outstanding shares.
 Stock dividend is measured at fair value
 Fractional warrants
 When stock dividends are issued, full share may not be issued.
 Fractional shares dividends may be resolved as follows:
a. Issuance of warrants for fractional shares. Shareholders may accumulate sufficient fractional warrants to
acquire full shares.
b. Cash may be paid in lieu of fractional shares. Allowed only if dividend is declared out of earnings. If the
stock dividend is declared out of share premium, cash payment is prohibited by law.
 Treasury shares as stock dividend
 Classified by the Corporation Code as property dividend.
 Since treasury shares are a component of shareholders’ equity and not a financial asset, the case is accounted
as stock dividend.
 Stock dividend is measured at the recorded cost of the treasury shares.
 Dividend out of capital
 General rule - Paid only to shareholders when the entity is dissolved and liquidated.
 Trust fund doctrine – It is illegal to return capital to shareholders during the lifetime of the corporation.
 Wasting asset doctrine – Wasting asset entity can declared dividends not only to the extent of retained earnings but
also to the extent of the accumulated depletion balance.
 Wasting asset entity – engaged in exploitation of natural resources (i.e. mining)
 Amount of dividend in excess of the retained earnings is charged to “Capital Liquidated” account. This is a contra
equity account.
 Other considerations on dividends
 The classification of a financial instrument as a financial liability or an equity instrument determines whether
interest, dividends, losses and gains relating to that instrument are recognized as income or expense in profit or
loss. Thus, dividend payments on shares wholly recognized as liabilities are recognized as expenses in the same way
as interest on a bond. (IAS 36)
 Dividends of redeemable preference shares classified as financial liability is charged to interest expense rather than
to retained earnings/dividend declared account.
 If stock dividends are declared by closely held entities, the amount charged to dividends is equal to the par or
stated value of shares.
 If stock dividends are declared based on proposed increase in authorized shares which has been filed but not yet
approved by SEC at the end of the reporting period, the general rule is that the proposed increase in authorized
shares and the stock dividends shall not be reflected in the financial statements. Disclosure is necessary.

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Part 2: Appropriation, Components of shareholders’ equity and Quasi-reorganization

 Appropriation of retained earnings
 The objective is to limit the amount of retained earnings to be declared as dividends
a. Legal appropriation
 Portion of the retained earnings must be appropriated for an amount equal to the cost of the treasury
shares.
b. Contractual appropriation
 Imposed for payment/redemption of issued securities (i.e. bonds, redeemable shares)
a. Retained earnings appropriated for sinking fund or bond redemption
b. Retained earnings appropriated for redemption of preference shares
c. Voluntary appropriation
 Appropriation at the discretion on the part of management
a. Retained earnings appropriated for plant expansion
b. Retained earnings appropriated for increase in working capital
c. Retained earnings appropriated for contingencies
 Components of retained earnings
 Statement of retained earnings is no longer a required component of a complete financial statements per IFRS. It is
shown as part of the statement in changes in equity.
 Items affecting retained earnings
a. Net income or net loss
b. Prior period errors
c. Dividends declared
d. Effect of change in accounting policy
e. Appropriation of retained earnings
 Reserves
 Distributable equity is the portion that can be distributed to shareholders as dividends without impairing legal
capital. This pertains to the unappropriated retained earnings.
 Non-distributable equity reserves represents items other than aggregate par or stated value of share capital and the
unappropriated retained earnings.
 Components of non-distributable equity reserves:
a. Share premium reserve – excess of par or stated value
b. Appropriation reserve – Appropriated retained earnings
c. Asset revaluation reserve – revaluation surplus
d. Other comprehensive income
 Comprehensive income
 Items presented in the statement of comprehensive income
a. Net income or net loss
b. Other comprehensive income
a. Unrealized gain or loss on financial asset at fair value though OCI
b. Gain or loss on foreign exchange translation
c. Change in revaluation surplus
d. Unrealized gain or loss from derivative contract designated as cash flow hedge
e. Remeasurements of defined benefit plan
f. Change in fair value attributable to credit risk of financial liability designated at fair value through profit and
loss.
 Statement of changes in equity
 The following changes in equity are presented:
a. Total comprehensive income for the period
b. For each component of equity, effects of changes in accounting policies and correction of errors.
c. For each component of equity, a reconciliation of beginning and ending carrying amount
 Quasi-reorganization
 A quasi reorganization must be approved by the SEC.
 Circumstances that may justify quasi reorganization:
a. Large deficit
b. Approved by shareholders and creditors
c. Cost basis of accounting for PPE becomes unrealistic
d. Fresh start appears desirable
 Corporate readjustments ay be accomplished through:
a. Recapitalization – Deficit is charged against share premium
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b. Revaluation of PPE - Deficit is charged against revaluation surplus
 SEC requirements for quasi-reorganization
a. Appraisal of PPE must be made by independent expert
b. Increase in PPE is credited to revaluation surplus
c. Adjustments in other assets are made through retained earnings
d. Deficit is charged against revaluation surplus
e. Retained earnings shall be restricted to the extent of deficit wiped out and cannot be declared as dividends.
f. Losses subsequent to quasi reorganization cannot be charged to remaining revaluation.
g. Disclosure of quasi reorganization is for at least 3 years.

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Illustrative Problems

1. Represents the cumulative balance of periodic earnings, dividend distributions, prior period adjustments and other
capital adjustments.
A. Shareholders’ equity C. Dividends
B. Retained earnings D. Capital
2. The procedure of restating assets, liabilities and share capital balances in conformity with fair value for the purpose
of eliminating deficit.
A. Quasi-revaluation C. Quasi-reengineering
B. Quasi-reorganization D. Quasi-reassessment
3. Accumulated losses resulting in a debit balance of the retained earnings.
A. Deficit C. Impairment loss
B. Revaluation loss D. Undervaluation
4. Dividends shall be recognized as liabilities on the
A. Date of declaration C. Date of payment
B. Date of record D. Date of distribution
5. The board of directors authorize payment of dividend on December 31, Year 1. Those who are registered as
shareholders on or before January 15, Year 2 are entitled to receive dividends. The distribution of the dividends will
be on February 14, Year 2. January 15, Year 2 is the
A. Date of declaration C. Date of payment
B. Date of record D. Date of distribution
6. The following dividends will result in the decrease of the total shareholders’ equity, except
A. Cash dividend C. Stock dividend
B. Property dividend D. Script dividend
7. Which of the following is a dividend out of capital
A. Stock dividend C. Scrip dividend
B. Liquidating dividend D. All of the foregoing
8. The measurement of stock dividends on the date of declaration is
Par value Market value Par value Market value
A. Small stock dividend Large stock dividend C. Small stock dividend Small stock dividend
B. Large stock dividend Small stock dividend D. Large stock dividend Large stock dividend
9. Small stock dividend is when the declared stock dividend is less than ______ of the outstanding shares
A. 10% C. 20%
B. 15% D. 25%
10. In closely held entities , if stock dividends are declared, the amount charged to retained earnings is at
A. Par value C. Book value
B. Fair market value D. No capitalization required
11. Under IFRIC 17, on the date of declaration, an entity shall measure a liability to distribute non-cash assets as a
dividend at
A. Carrying amount of the asset C. Cost of the asset
B. Fair value of the asset D. Lower amount between A and B
12. Under IFRIC 17, change in fair value of the noncash dividend shall be reflected in the measurement of the dividend
payable on the
A. Date of settlement C. Both A and B
B. Reporting date D. Remeasurement is not necessary
13. Under IFRIC 17, when an entity settles the dividend payable, it shall recognize the difference, if any, between the
carrying amount of the assets distributed and the carrying amount of the dividend payable
A. In other comprehensive income C. As a deferred charge
B. Directly to retained earnings D. In profit or loss
14. Under IFRS 5, An entity shall measure a non-current asset (or disposal group) classified as held for distribution to
owners at the
A. Carrying amount C. Lower amount between A and B
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B. Fair value less costs to distribute D. Fair value
15. Dividends of equity instruments classified as financial liability is charged to
A. Retained earnings C. Directly to the financial liability account
B. Other comprehensive income D. Profit or loss
16. Wasting asset entity can declared dividends not only to the extent of retained earnings but also to the extent of
A. Share premium C. Carrying amount of the wasting asset
B. Accumulated depletion D. Accumulated depreciation
17. Which of the following statement is true?
A. Stock dividends may be declared from premium on par value shares.
B. Treasury shares may be declared as stock dividend.
C. An entity may pay cash in lieu of fractional shares if dividend is declared out of earnings.
D. All of the foregoing.
18. The following will affect retained earnings, except
A. Change in accounting policy C. Items in other comprehensive income
B. Prior period adjustment D. Dividend declaration
19. The following will decrease retained earnings, except
A. Dividends declared
B. Net loss
C. Change in accounting policy that overstate earnings in previous periods
D. Correction of prior period errors that overstate cost of sales in the previous periods
20. Which of the following is a legal appropriation?
A. Retained earnings appropriated for plant expansion
B. Retained earnings appropriated for treasury shares
C. Retained earnings appropriated for plant expansion
D. Retained earnings appropriated for redemption of preference shares
21. Components of non-distributable equity reserves do not include
A. Share capital C. Appropriated retained earnings
B. Share premium D. Other comprehensive income
22. Which of the following will not give rise to other comprehensive income?
A. Change in revaluation surplus C. Loss on extinguishment of debt
B. Gain on foreign exchange translation D. None of the foregoing
23. In quasi-reorganization through recapitalization, deficit is eliminated in the
A. Share capital C. Share premium
B. Other comprehensive income D. Revaluation surplus
24. SEC requires disclosure of quasi-reorganization for at least
A. 3 years C. 5 years
B. 2 years D. 4 years
25. On May 31, year 1, Ball Corporation’s board of directors declared a 10% stock dividend. The market price of Ball’s
30,000 outstanding shares of P20 par value common stock was P80 per share on that date. The stock dividend was
distributed on July 31, year 1, when the stock’s market price was P100 per share. What amount should Ball credit to
share premium for this stock dividend?
A. -0- C. 180,000
B. 240,000 D. 300,000
26. On Novembr 30 Year 1, a company declared property dividends when the property has a carrying amount of
P500,000 and fair value of P520,000. On December 31, Year 1, the fair value less cost to distribute of the property is
P480,000. On February 25, the date of payment, the property has fair value less cost to distribute of P470,000. The
gain or loss on distribution of the property dividend is
A. 30,000 loss C. 10,000 loss
B. 50,000 gain D. 50,000 loss
27. On March 30, year 1, Mitz Co. declared a 30% ordinary share dividend. Shares were selling on the market on this
date at P25 per share. The par value is P10 per share and 180,000 shares are outstanding. In distributing the stock
dividend, Mitz Co. issued fractional share warrants totaling 600 shares. Assuming that 60% of the warrants are
exercised and the remaining warrants expire, the entry to record the exercise and expiration of the fractional share
warrants is
A. Fractional Share Warrants Issued 15,000
Ordinary Share 9,000
Share premium 6,000
B. Fractional Share Warrants Issued 6,000
Ordinary Share 3,600
Share premium 2,400
C. Fractional Share Warrants Issued 15,000
Ordinary Share 3,600
Share premium 11,400
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D. Fractional Share Warrants Issued 15,000
Ordinary Share 15,000
28. Rod Corp. had 700,000 ordinary shares authorized and 300,000 shares outstanding on January 01, Year 1.
The transaction for Year 1 follows:
Jan 01 Declared and distributed 10% stock dividends
Jun 30 Acquired 100,000 shares
Aug 01 Issued 50,000 shares
Nov 30 Declared 2-for-1 share split
How many are the ordinary shares outstanding?
A. 560,000 C. 630,000
B. 600,000 D. 660,000
29. Beauty Company has the following information:
Preference share capital P500 par 1,100,000
Ordinary share capital, P100 par 600,000
Treasury shares (ordinary), P100 cost 110,000
Retained earnings 2,500,000
Subsequently, the company declared, 100% stock dividend on both classes of shares. Also, the company declared
10% cash dividend on preference shareholders and P10 cash dividend per ordinary share. What is the shareholders’
equity after considering the dividends?
A. 4,090,000 C. 3,820,000
B. 3,810,000 D. 3,931,000
30. On December 31, Year 1, a wasting asset entity declared P800,000 cash dividends. The data of the entity on that
date follows:
Accumulated depletion 400,000
Share capital 9,000,000
Share premium 300,000
Retained earnings (adjusted for net income, before dividends) 300,000
Net income 200,000
The liquidating dividend would be valued at
A. 700,000 C. 300,000
B. 800,000 D. 400,000
31. Retained earnings beginning balance is P750,000. Other information are as follows: current year net income of
P230,000, dividends of P400,000, other comprehensive income of P70,000 and prior period adjustment for
overstatement of cost of sales amounting to P20,000. Retained earnings beginning balance would be
A. 670,000 C. 560,000
B. 630,000 D. 600,000
32. At the beginning of the current year, the company reported P1,750,000 of appropriated retained earnings for the
construction of the new building which was completed late in the current year. For the current year, P1,200,000
was appropriated for plant expansion. P1,500,000 cash was restricted for the retirement of bonds payable. Also, the
company acquired treasury shares for a total cost of P500,000. On December 31 of the current year, the entity
should report appropriated retained earnings of
A. 1,200,000 C. 2,950,000
B. 2,700,000 D. 3,200,000
33. During the first three years of operation, the company had net income of P800,000, P2,500,000 and P3,000,000,
respectively. The entity also declared and paid dividends totalling P2,000,000 for the last three years. For the
current year, Year 4, the company reported the following
Net income before tax 4,800,000
Prior period adjustment-understatement of depreciation (before tax) 400,000
Cumulative decrease in income from change in inventory method (before tax) 700,000
Dividends declared 2,000,000
Income tax rate 30%
What is the retained earnings as of December 31, Year 4?
A. 4,890,000 B. 5,450,000 C. 6,000,000 D. 5,870,000
34. The company has P7 million ordinary share capital, P1.6 million share premium and P900,000 deficit in retained
earnings. Recapitalization was effected as follows:
 Inventory recorded at P6.5 million has market value of P6.4 million t year-end.
 PPE with carrying amount of P12 million has P8 million sound value.
 Par value of share is reduced from P10 to 5.
What should be the Shareholder’s equity after quasi-reorganization?
A. 3,300,000 B. 3,500,000 C. 3,700,000 D. 3,600,000

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