Which of the following best describes stockholders’ equity?
The initial claim on value of a company’s assets before it pays off its liabilities.
The difference between a company’s assets and liabilities.
Purple Dog Pet Supply Inc. (PDPS) released its annual results and financial statements. Teresa is reading the summary on Purple Dog’s website. In its annual report this year PDPS reported a net income of $145,000. Last year, the company reported a retained earnings balance of $493,000, whereas this year it increased to $580,000. If Purple Dog Pet Supply Inc. paid out dividends this year, how much did they pay out?
A. $232,000
B. $308,000
C. $58,000
D. $1,073,000
The correct answer and explanation is :
The correct answer is C. $58,000.
To explain why this is the correct answer, let’s break down the relationship between net income, retained earnings, and dividends.
Stockholders’ Equity
Stockholders’ equity represents the ownership interest in a company, which is essentially the difference between its total assets and total liabilities. Therefore, it’s the second option provided: “The difference between a company’s assets and liabilities.”
The Retained Earnings Calculation
Retained earnings reflect the portion of net income that a company keeps for reinvestment in the business, rather than paying it out as dividends. The formula to determine the change in retained earnings is:
[
\text{Ending Retained Earnings} = \text{Beginning Retained Earnings} + \text{Net Income} – \text{Dividends Paid}
]
Given Information
- Beginning Retained Earnings (last year): $493,000
- Ending Retained Earnings (this year): $580,000
- Net Income (this year): $145,000
Now, we can use the formula to find the dividends paid:
[
580,000 = 493,000 + 145,000 – \text{Dividends Paid}
]
Solving for dividends:
[
\text{Dividends Paid} = 493,000 + 145,000 – 580,000 = 58,000
]
Thus, Purple Dog Pet Supply Inc. paid out $58,000 in dividends.
Explanation of the Answer:
- Net income of $145,000 was added to the retained earnings.
- The increase in retained earnings was $580,000 – $493,000 = $87,000.
- The total amount that could have gone into retained earnings was $145,000 (net income), but since only $87,000 went into retained earnings, the remainder must have been paid out as dividends.
- Therefore, the dividends paid were $145,000 – $87,000 = $58,000.
This is why the correct answer is C. $58,000.