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Chapter 15: Question 21Q (page 774)

Dividends are sometimes said to have been paid “out of retained earnings.” What is the error, if any, in that statement?

Short Answer

Expert verified

Here the statement contains an error as the retained earning does not give surety for a dividend payment.

Step by step solution

01

Meaning of Dividend

Companies pay dividends in exchange for sharing profits with their shareholders. Dividends are treated as income for investors because a company provides investors with a return on their investment.

02

Error in the Statement

Paying dividends with cash is the way dividends are done. To be able to distribute profits legally, retained earnings must have a balance. However, this does not guarantee an ability to pay a dividendif the cash situation does not allow it.

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Most popular questions from this chapter

(Stock Dividends and Splits) The directors of Merchant Corporation are considering the issuance of a stock dividend. They have asked you to discuss the proposed action by answering the following questions.

Instructions

  1. What is a stock dividend? How is a stock dividend distinguished from a stock split (1) from a legal standpoint and (2) from an accounting standpoint?
  2. For what reasons does a corporation usually declare a stock dividend? A stock split?
  3. Discuss the amount, if any, of retained earnings to be capitalized in connection with a stock dividend

Arantxa Corporation has outstanding 20,000 shares of \(5 par value common stock. On August 1, 2017, Arantxa reacquired 200 shares at \)80 per share. On November 1, Arantxa reissued the 200 shares at $70 per share. Arantxa had no previous treasury stock transactions. Prepare Arantxa’s journal entries to record these transactions using the cost method.

(Equity Transactions and Statement Preparation) On January 5, 2017, Phelps Corporation received a charter granting the right to issue 5,000 shares of \(100 par value, 8% cumulative and nonparticipating preferred stock, and 50,000 shares of \)10 par value common stock. It then completed these transactions.

Jan. 11 Issued 20,000 shares of common stock at \(16 per share.

Feb. 1 Issued to Sanchez Corp. 4,000 shares of preferred stock for the

following assets: equipment with a fair value of \)50,000; a factory

building with a fair value of \(160,000; and land with an

appraised value of \)270,000.

July 29 Purchased 1,800 shares of common stock at \(17 per share. (Use cost

method.)

Aug. 10 Sold the 1,800 treasury shares at \)14 per share.

Dec. 31 Declared a \(0.25 per share cash dividend on the common stock and

declared the preferred dividend.

Dec. 31 Closed the Income Summary account. There was a \)175,700 net

income.

Instructions

  1. Record the journal entries for the transactions listed above.
  2. Prepare the stockholders’ equity section of Phelps Corporation’s balance sheet as of December 31, 2017.

Stock splits and stock dividends may be used by a corporation to change the number of shares of its stock outstanding.

  1. What is meant by a stock split effected in the form of a dividend?
  2. From an accounting viewpoint, explain how the stock split effected in the form of a dividend differs from an ordinary stock dividend.
  3. How should a stock dividend that has been declared but not yet issued be classified in a balance sheet? Why?

Graves Mining Company declared, on April 20, a dividend of \(500,000 payable on June 1. Of this amount, \)125,000 is a return of capital. Prepare the April 20 and June 1 entries for Graves.
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