Retention Dividend Growth

Retention Dividend Growth

The retention of profit results in dividend growth. the dividend growth is calculated by multiplying the proportion of retention with the rate of return on investment . The formula may be narrated as under

Growth = Rate on investment x Proportion of retention

 Retention Dividend Growth Example

ABC Company retained 20% of its profit and the rate of return on investment is 12%. Calculated the dividend growth rate?

Solution

Growth = Rate on investment x Proportion of retention

= 20% x 12%

= 2.4%

What are retained Earning

What are retained Earning

Retained earnings are the profit of the company which is not distributed to the shareholder.

Share Capital	$ 100,000
Retained Earning	$ 20,000
Total equity	$ 120,000

What is the purpose of retained earning?

The retained earnings are used as source of finance. Retained earnings are shown in the balance sheet as part of capital. Retained earnings also result in dividend growth.

Why retained earnings are used as source of financing

There are number of reason for using the retained earnings as source of financing which includes i.e avoid new issue cost, avoid new issue legal formalities , and new issue is a time consuming job.

What are new issue costs?

There are number of cost involved in new issue like legal charges for legal issue, newspaper advertisement for new issue of share, printing and stationary cost etc.

How the dividend growth is calculated?

The dividend growth is calculated by following formula

Growth = Proportion of retention x Rate of return on investment

Bounded Rationality concept

Bounded Rationality concept

Bounded rationality concept believes that human makes rational decision as per their understanding and human being does not have absolute powers of understanding. The human being can make the decision as per his ability to understand the things. Therefore different people make different decision in the same situation because their level of understanding differs.

Bounded rationality explains that no human being can make perfect decision and there are many limitations he has to face while making decisions. For example he cannot evaluate all the possible option available for decision making. He cannot predict the future with certainty.

Unrealized profit in inventory

 Unrealized profit in inventory

The group companies are not deemed to earn profit from each other, therefore, if there is unsold inventory in the group which includes a profit from a group company. Then this profit must be eliminated from the inventory. It means that not only the retained earnings will be reduced by the amount of unrealized profit but the inventory amount will also be reduced.

Example of unrealized profit

ABC & company sold $ 50,000 to A & Co. The A & Co has subsidiary with name S & Co. The good sold to S by A & Co is $ 60,000. The goods are in the stock of S & Co at the reporting date.

Solution

 In this example the unrealized profit is $ 10,000 i.e. ( 60,000 – 50,000) this is the amount of profit earned the A & Co from S & Co and the inventory is still in S & Co , therefore this is unrealized profit for Group.

Date	Particulars	Dr.	Cr.
	Retained Earning	$ 10,000
	Stock		$10,000

Cash in Transit

Cash in Transit

It is to be noted that only equal inter company transaction are cancelled if the transaction are not equal than first the adjustment entry is passed and then transaction are cancelled.

Example of Cash in Transit

Pioneer & Co show a receivable of $ 80,000 from Soria & Co, while Soria & Co only show a balance of $ 60 payable to Pioneer. The investigation reveals that $ 20,000 has paid to the pioneer & co but not accounted for yet by the pioneer & Co.

1.      Journal Entry for cash in Transit

Pioneer Co will account for the following entry in its books of accounts.

Date	Particulars	Dr.	Cr.
	Cash	$ 20,000
	Receivable from Soria		$ 20,000

2.      Cancellation of Equal Transaction

Now the pioneer & Co shows a balance of $ 60,000 receivable from Soria and Soria & Co shows a balance of same amount payable to pioneer & co and therefore these both balances can be cancelled.

3.      Cash increase

It is important to note that cash in Pioneer Company will increase by $ 20,000 and the same will also be reflected in the group accounts.

Example of Goodwill with NCI

Example of Goodwill with NCI

The goodwill in case of partial acquisition is calculated as under

Cost of investment

Add: Non Controlling Interest

Less: Fair value of Net Assets

Cost of investment and non controlling interest is added and fair value of net asset at acquisition date is deducted to calculate the Goodwill.

Example

Peen & Co purchased 60,000 Share	$ 400,000
Total shares of Sheen & Co	100,000
Net asset of Sheen & Co	$ 500,000

Solution

There are two steps of calculating the Goodwill i.e. first is to calculate the NCI and then Goodwill.

1.       Calculate NCI

% of Shareholding by NCI	40%
Net Assets	$ 500,000
NCI as proportion to  net Assets	$ 200,000

2.       Calculate Goodwill

Cost of Investment	$ 400,000
NCI	$ 200,000
Less: Net Asset Fair value	$ 500,000
Goodwill	$ 100,000

Example of Goodwill

Example of Goodwill

Goodwill is excess amount paid for acquiring business i.e. amount exceeds the fair value of net assets. Goodwill is paid for other asset which can not directly recognize but will contribute in future economic benefit.  These asset include the reputation of the acquired business, customer base etc.

Net asset acquired	$ 200,000
Amount paid	$ 250,000

Calculate the Goodwill

Solution

Goodwill is calculated by deducting the net asset from the investment.

Investment in XYZ	$ 250,000
Less: Net value of asset acquired	$ 200,000
Goodwill	$ 50,000

NCI Calculation Date

NCI Calculation Date

Initially NCI is calculated at acquisition date and thereafter at each reporting date NCI is calculated by the adding the after acquisition profit as proportion to NCI Shareholding. For example there is NCI of $ 100 at the acquisition date and subsidiary earn a profit of $80 then NCI at the reporting and Parent hold 80% shareholding then the NCI at reporting date will be calculated as under.

NCI at Acquisition Date	$ 100
Profit for the year (NCI proportional) 20% of 80	$  16
NCI at reporting Date	$ 116

Non controlling Interest at acquisition date (Fair value or Net Asset basis)

Add: NCI share of Subsidiary Profit

Example Non Controlling Interest Calculation reporting date

600,000 Shares acquired by Pillion & Co 01 Jan 2012
Shares of Sillion & Co	800,000
Worth of Net Asset of Silicon & Co	$ 2,500,000
Share price at acquisition	$ 3
Profit for the year	$120,000

Solution

Non Controlling Interest Calculation Reporting date (Fair value)

1.       % of Shareholding

Shares Purchased	600,000
Total Shares	800,000
Shareholding % (600,000/800,000)	75%

2.       Calculate the NCI at acquisition Date (Fair Value)

	Fair Value
Shares hold	200,000
Per Share price	$ 3
NCI is ( 200,000 x 3)	$ 600,000

3.       NCI at Reporting Date

NCI at Acquisition Date	$600,000
NCI Share in after acquisition profit ( 25% x 120,000)	$  30,000
NCI at Reporting Date (Fair Value)	$ 630,000

Non Controlling Interest Calculation Reporting date (Net Asset)

1.       % of Shareholding

Shares Purchased	600,000
Total Shares	800,000
Shareholding % (600,000/800,000)	75%

2.       Calculate the NCI at acquisition Date (Net Asset)

Net Assets of Sillion	2,500,000
NCI Shareholding ( 25%)	25%
NCI at acquisition Date	$ 625,000

3.       NCI at Reporting Date (Net Asset)

NCI at acquisition date	$ 625,000
25% after acquisition profit ( 25% x 120,000)	$   30,000
NCI at Reporting Date	$ 655,000

Examples of Non Controlling Interest

Examples of Non Controlling Interest

If a parent acquired less than 100% shares then there is no controlling interest exist. The non controlling interest is basically interest of shareholder than parent. For example ABC Company acquired 80,000 shares out of 100,000 shares of XYZ, then this is 80% acquisition and non controlling interest in this case would be 20%.

Types of Measurement of Non Controlling Interest

There are two methods available for measuring the non controlling assets.

1.      Fair Value

2.      Net asset methods

Fair value method

In fair value method NCI is measured at fair value of NCI i.e. is normally the market value of shares of subsidiary at the date of acquisition.

Net Asset method

In this method the net asset of subsidiary is calculated and non controlling interest is the proportion of net assets held by the non controlling equity holder.

Non Controlling Interest example

Parent acquired 700,000 Shares
Total Shares of Subsidiary (S & Co)	1,000,000
Net Asset of Subsidiary	$ 3,500,000
Share price at acquisition	$ 3

Calculate the non controlling interest under fair value and net asset method

Solution

1.      Fair value method

Number of Share held by Non controlling equity holder	300,000
Share price $ 4
Fair value of Non controlling interest	$1,200,000

2.      Net Asset Method

Net Assets	$ 3,500,000
Non Controlling Interest	30%
Non Controlling interest	$ 1,050,000