Mayfair Corporation has outstanding 70,000 shares of $1 par value common stock as well as 20,000 shares of 7%, $100 par value cumulative preferred stock. At the beginning of the year, the balance in retained earnings was $800,000, and one year's dividends were in arrears. Net income for the current year is $580,000. Compute the balance in retained earnings at the end of the year if Mayfair Corporation pays a dividend of $3 per share on its common stock this year.

$890,000.

Explanation:

Net income, also known as Earnings After Tax, is the income the company has generated after paying for all the expenses including manufacturing, operating, administrative, interest, and taxes. The management retains a portion of this amount and distribute the remaining among its shareholders. Net Income has a credit balance. To close it, it is transferred to retained earnings by posting the following entry:

Net Income                          Debit

                 Retained Earnings                             Credit

Then the amount that is to be paid to shareholders is deducted from retained earnings.

In this case, retained earnings has an opening balance of $800,000. The Net Income for the year is added with this figure. Out of the total retained earnings, dividends of preferred shareholders are paid including any cumulative, along with the dividends of common shareholders. The resulting amount is the Ending balance of retained earnings.

Calculation

Opening retained earnings                                                               $800,000

Add: Net income                                                                                  580,000

Less:

Arrears of preferred dividend (20,000 * 7% * 100)                           (140,000)

Preferred dividend of current year (20,000 * 7% * 100)                   (140,000)

Dividend on common stock (3 * 70,000)                                          (210,000)

Retained earnings at year end                                                        $890,000