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Chapter 15: Question 20Q (page 810)

What are the principal considerations of a board of directors in making decisions involving dividend declarations? Discuss briefly.

Short Answer

Expert verified

The board of directors must consider both the legal and economic implicationsof a dividend when determining whether one should be declared.

Step by step solution

01

Meaning of Dividend

Whether paid in cash or in-kind, dividends are a payment made by an organizationto its shareholders. It is measured as the return of the investment made by the stockholders.

02

In general, when considering the validity of a dividend declaration, directors should examine the following factors

1. The correct foundation for dividend distribution is normally retained earningsunless they are legally bound in some way.

2. Additional paid-in capitalmay be utilized for dividends in some states, while preferred stock payments may be limited.

3. Any retained earnings deficits and debitsin paid-in capital accounts must be repaired before any dividends are paid.

4. In some areas, dividends may not be enough to bring retained earnings below the cost of treasury shares maintained.

03

The board of directors should evaluate the following factors to ensure that dividends are financially sound

1. The availability (liquidity)of assets for distribution

2. Creditor agreements

3. The impacts of a dividend on investor perceptions(e.g., maintaining a projected "payout ratio")

4. The dividend size is evaluated in relation to the possibility of paying dividends in future bad years. It's also worth considering whether or not existing facilities can be expanded or replaced.

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Most popular questions from this chapter

For what reasons might a corporation purchase its own stock?

(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鈥� equity section of Phelps Corporation鈥檚 balance sheet as of December 31, 2017.

(Stock Dividends and Stock Split) Oregon Inc. \(10 par common stock is selling for \)110 per share. Four million shares are currently issued and outstanding. The board of directors wishes to stimulate interest in Oregon common stock before a forthcoming stock issue but does not wish to distribute capital at this time. The board also believes that too many adjustments to the stockholders鈥� equity section, especially retained earnings, might discourage potential investors. The board has considered three options for stimulating interest in the stock:

The board has considered three options for stimulating interest in the stock:

  1. A 20% stock dividend.
  2. A 100% stock dividend.
  3. A 2-for-1 stock split.

Instructions

Acting as financial advisor to the board, you have been asked to report briefly on each option and, considering the board鈥檚 wishes, make a recommendation. Discuss the effects of each of the foregoing options.

Nottebart Corporation has outstanding 10,000 shares of \(100 par value, 6% preferred stock and 60,000 shares of \)10 par value common stock. The preferred stock was issued in January 2017, and no dividends were declared in 2017 or 2018. In 2019, Nottebart declares a cash dividend of $300,000. How will the dividend be shared by common and preferred stockholders if the preferred is (a) noncumulative and (b) cumulative?

How are restrictions of retained earnings reported?
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