To demonstrate corporate accounting assume that five

To demonstrate corporate accounting, assume that five persons secured a
certificate of incorporation for a new corporation. Each invested $10,000 in the cor-
poration by buying 1,000 of its common shares. The corporation's entry to record
their investments is
CORPORATE
ACCOUNTING
LO 7
Explain the nature of a
corporation’s retained
earnings and their rela-
tionship to the declaration
of dividends.

208 Chapter 4
If during its first year the corporation earned $20,000, the entry to close its In-
come Summary account is
Jan. 5 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000.00
Common Shares . . . . . . . . . . . . . . . . . . . . . . . . 50,000.00
Issued 5,000 common shares for cash.
Dec. 31 Income Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000.00
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . 20,000.00
To close the Income Summary account.
If these are the only entries that affected the Common Shares and Retained
Earnings accounts during the first year, the corporation ’ s year-end balance sheet
will show the shareholders ’ equity as follows:
Shareholders' Equity
Share capital – common: 5,000 shares outstanding . . $50,000
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . 20,000
_______
Total shareholders ’ equity . . . . . . . . . . . . . . . . . . $70,000
Because a corporation is a separate legal entity, the names of its shareholders
usually are of little interest to a balance sheet reader and are not shown in the eq-
uity section. However, in this case, the section does show that the net asset or eq-
uity of the corporation is $70,000. Of this amount, $50,000 resulted from the is-
suance of shares to the shareholders and $20,000 was the result of net income that
has not been paid out as dividends.
Perhaps the concept of retained earnings would be clearer if the balance sheet
item were labeled “ Shareholders ’ equity resulting from earnings. ” However, the re-
tained earnings caption is commonly used; it does not represent a specific amount
of cash or any other asset. These are shown in the asset section of the balance
sheet. Retained earnings represent the shareholders ’ equity resulting from earnings.
To continue, assume that on January 10 of the corporation's second year, its
board of directors met and by vote declared a $1 per share dividend payable on
February 1 to the January 25 shareholders of record (shareholders according to
the corporation ’ s records). The entry to record the declaration of the dividend is as
follows:
Jan. 10 Cash Dividends Declared . . . . . . . . . . . . . . . . . . . . . 5,000.00
Common Dividend Payable . . . . . . . . . . . . . . . . 5,000.00
Declared a $1 per share dividend.
LO 8
Prepare entries to record
the declaration and pay-
ment of a dividend and to
close the temporary ac-
counts of a corporation.