Question

ABC Corporation had the following shareholders’ equity balances at January 1, 2020:

Common shares, unlimited authorized, 400,000 issued                                       $800,000

Retained earnings                                                                                             120,000                     

Accumulated other comprehensive income                                                                30,000

The following events occurred in 2020:

• Issued 50,000 common shares for $150,000 cash.
• Declared and paid cash dividends of $25,000.
• Reported net income of $40,000.
• Reported other comprehensive income of $10,000.
• At the end of the year, the fair market value of common shares was $5/share.
• Completed a 2:1 stock-split.

Required:

1. Prepare a statement of changes in equity using the following tabular format (i.e., input numbers into the table below):

	Common Shares	Retained Earnings	Accumulated Other Comprehensive Income	Total
January 1, 2020
December 31, 2020

2. Would your answer to part a) above change if the company paid a stock dividend rather than a cash dividend? Explain.

3. Briefly explain why the shareholders’ equity section is important to users of financial statements.
4. Provide your views on the following quote from the President of Medical Ltd, a struggling pharmaceutical company that focuses on developing new and innovative medications:

“Investors are important. We need to please them. We need to maintain a high dividend payout ratio…whatever it takes…I want to show an increasing dividend payout ratio….”

Answer 1

a.

Statement of changes in equity
	Common shares	Retained Earnings	Accumulated other comprehensive income	Total
January 1, 2020	800,000	120,000	30,000	950,000
Share capital Issued	150,000	-	-	150,000
Income for the year	-	40,000	-	40,000
Other comprehensive income	-	-	10,000	10,000
Dividends	-	-25,000	-	-25,000
December 31, 2020	950,000	135,000	40,000	1,125,000

If the company is paying stock dividend, it will affect the retained earnings as well as common stock of the company. There will be a change in the common shares also if company issues stock dividend.

Importance of shareholders equity

The share holders equity part is important for those who are interested to invest in the company. Because, this section gives a conclusion about the company's' capital, reserves, retained profit, dividend etc. It is the indicator of the net worth, dividend income etc. A steady growth in a company’s shareholders’ equity by way of increasing retained earnings, as opposed to expanding shareholder base, means the accumulation of investment returns for current equity shareholders.

b) "Investors are important. We need to please them. We need to maintain a high dividend payout ratio…whatever it takes…I want to show an increasing dividend payout ratio….”

The dividend are the part of profit which are distributed to share holders of the company. The dividend payout ratio gives the percentage in which the net income of the company are distributed to the share holders of the company. A payout ratio of 20% means for every dollar the company earns in net income, 20% is being returned to shareholders as a dividend. The investors mostly check out the dividend pay out ratio to understand the company better. A steady dividend payout is a symbol of sustainable profit to the company. A reasonably high dividend payout ratio indicates a management that is concerned about returning value to the shareholders. Investors should be cautious of payout ratios over 100% because this means the company is giving away more than it earns. Over time, this is unsustainable.