Financial Accounting and Reporting

expansion.
4. To smooth out dividend payments from year to year by accumulating earnings in good years
and using such accumulated earnings as a basis for dividends in bad years.
5. To build up a cushion or buffer against possible losses or errors in the calculation of profits.
Before declaring a dividend, management must consider availability of funds to pay the dividend.
Dividends are of the following types:
1. Cash dividends → The board of directors votes on the declaration of cash dividends. Upon
approval of the resolution, the board declares a dividend. A declared cash dividend is a liability.
Because payment is generally required very soon, it is usually a current liability. Companies do
not declare or pay cash dividends on treasury shares.
2. Property dividends → Dividends payable in assets of the corporation other than cash are called
property dividends or dividends in kind. Property dividends may be merchandise, real estate, or
investments, or whatever form of the board of directors designates. When declaring a property
dividend, the corporation should restate at fair value the property it will distribute, recognizing
any gain or loss as the difference between the property’s fair value and carrying value at date of
declaration.
3. Liquidating dividends → Some corporations use amounts paid in by shareholders as a basis for
dividends. Dividends based on other than retained earnings are sometimes described as
liquidating dividends. This term implies that such dividends are a return of the shareholder’s
investment rather than of profits. In other words, any dividend not based on earnings reduces
amounts paid-in by shareholders and to that extent, it is a liquidating dividend.
4. Share dividends → Companies sometimes issue a share dividend. In this case, the company
distributes no assets. A share dividend therefore is the issuance by a corporation of its own
shares to its shareholders on a pro rata basis, without receiving any consideration. In recording a
share dividend, some believe that the company should transfer the par value of the shares
issued as a dividend form retained earnings to share capital.
To reduce the market price of each share, companies use the common device of a share split.
A share split increases the number of shares outstanding and decreases the par or stated value
per share. A share dividend, although it increases the number of shares outstanding, does not
decrease the par value; thus, it increases the total par value of outstanding shares.
Companies are also required to present a statement of changes in equity. The statement of
changes in equity includes the following:
1. Total comprehensive income for the period
2. For each component of equity, the effects of retrospective application or retrospective
restatement
3. For each component of equity, a reconciliation between the carrying amount at the beginning
and the end of the period, separately disclosing changes resulting from:
(a) Profit or loss;
(b) Each item of other comprehensive income; and
(c) Transactions with owners in their capacity as owners, showing separately contributions by and
distributions to owners and changes in ownership interests in subsidiaries that do not result in a
loss of control.
Analysts use equity ratios to evaluate a company’s profitability and long-term solvency.
The return on ordinary share equity measures profitability from the ordinary shareholders’
viewpoint. This ratio shows how many dollars of net income the company earned for each dollar
invested by the owners. Return on equity equals net income less preference dividends, divided
by average ordinary shareholders’ equity. Trading on the equity describes the practice of using
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