The following illustration will show the necessary entries in accordance with the two methods.
Problem. Assume that the net profits of Jackson & Co. are $25,000. The directors declare an 8% dividend on the outstanding capital stock of $100,000, and order $5,000 to be transferred to a reserve for buildings and $7,000 to a reserve for the cancellation of a bond issue.
First Method
| Profit and Loss | 25,000.00 | ||
| Surplus | 25,000.00 | ||
| To transfer net profits to Surplus. | |||
| Surplus | 20,000.00 | ||
| Dividends Payable | 8,000.00 | ||
| Building Fund Reserve | 5,000.00 | ||
| Sinking Fund Reserve | 7,000.00 | ||
Second Method
| Profit and Loss | 20,000.00 | ||
| Dividends Payable | 8,000.00 | ||
| Building Fund Reserve | 5,000.00 | ||
| Sinking Fund Reserve | 7,000.00 | ||
| To appropriate profits as per resolution of the directors. | |||
| Profit and Loss | 5,000.00 | ||
| Surplus | 5,000.00 | ||
| To transfer balance to Surplus account. | |||
Dividend Liability.—The student should note that the effect of a dividend declaration is to change a portion of the proprietorship into a liability. Surplus is decreased and liabilities are increased. The liability so created ranks with other liabilities, i.e., the assets of the corporation may be used to pay the liability to its stockholders equally with the payment of liabilities to outside creditors. The payment of such dividend is recorded by the cancellation of the dividend liability, as follows:
| Dividends Payable | 8,000.00 | ||
| Cash | 8,000.00 | ||
Where there is more than one class of stock outstanding, it is customary to keep separate dividend accounts with each class.
Other Methods of Adjusting and Closing the Books.—It seems desirable at this point, although the material is applicable to any type of business organization, to discuss other methods of adjusting and closing the books than those heretofore explained. In [Chapter XXVIII] and previous chapters, the methods of handling deferred expense and income, and of summarizing the merchandising transactions were shown. The method given there of adjusting the ledger because of deferred expenses rested upon a classification of the various expense accounts to be adjusted as temporary proprietorship accounts. The method of adjustment effected a transfer out of the current part of the account, the asset portion of the expense, and carried it over into the next period. The balance remaining in the account after this adjustment shows the expense, that is, the amount of service or use, chargeable to the current period.