VIII – AUDIT OF EQUITY

PROBLEM NO. 1 - Equity components

SOLUTION:

Requirement Nos. 1 to 4
Authorized share capital 4,000,000
Unissued share capital (800,000)

Issued share capital 3,200,000

Subscribed share capital 480,000
Subscriptions receivable (120,000) 360,000

Share premium
Premium on share capital 320,000
Gain on sale of treasury shares 80,000
Donated capital 800,000
(
Stock warrants outstanding 200,000 1,400,000 1)
(
Contributed capital 4,960,000 2)
Retained earnings
Appropriated for sinking fund 400,000
Appropriated for treasury shares 144,000
(
Total appropriated retained earnings 544,000 3)
Unappropriated (P720,000 - P144,000) 576,000 1,120,000

Revaluation surplus 800,000

Net unrealized loss on available for sale securities (96,000)
Treasury shares (144,000)
(
Total equity 6,640,000 4)

1
 Requirement No. 5
Issued share capital 3,200,000
Subscribed share capital 480,000

Legal capital 3,680,000 (5) ¸

PROBLEM NO. 2 - Analysis of transactions affecting equity components

SOLUTION:
2012
Transaction
12.31.11 s 12.31.12

Share capital - PS 900,000 900,000

Share capital - OS 600,000 1/6 22,500 649,950
3/15 18,000
9/14 9,450
Subscribed share capital-OS - 2/28 21,000 -
3/15 (18,000)
3/15 (3,000)
Subscriptions receivable - 2/28 (273,000) -
3/15 234,000
3/15 39,000
1,200,00 2,158,80
Share premium 0 1/6 348,750 0
1/31 36,000
2/28 525,000
3/15 (75,000)
3/15 39,000
9/14 (28,350)
9/14 113,400
Retained earnings - appropriated - 12/3 108,000 108,000

2
 1
3,300,00 3,451,25
Retained earnings - unappropriated 0 4/30 (950,000) 0
8/30 (12,000)
11/3
0 (1,290,900)
12/1
5 (54,000)
12/3
1 2,585,650
1/8 (19,500)
12/3
1 (108,000)
(108,000
Treasury shares - 2/22 (180,000) )
8/30 72,000
6,000,00 7,160,00
0 0

Journal entries for 2012

1/6 Land (22,500 shares x P16.50) 371,250

Share capital-OS (22,500 shares x P1) 22,500
Share premium-EOP 348,750

1/31 Cash (1,200 x P1,000 x .98) 1,176,000

Discount on bonds payable (P1,200,000 -
P1,140,000) 60,000
1,200,00
Bonds payable 0
Share premium-warrants 36,000

Issue price with 1,176,000

Issue price without (1,200 x P1,000,000 x .
95) (1,140,000)

Equity component 36,000

2/22 Treasury shares (7,500 x P24) 180,000

3
 Cash 180,000

2/28 Cash (21,000 x P26 x 50%) 273,000

Subscriptions receivable (21,000 x P26 x
50%) 273,000
Subscribed share capital-OS (21,000 shares x
P1) 21,000
Share premium-EOP 525,000

3/15 Cash (18,000 x P26 x 50%) 234,000

Subscriptions receivable 234,000

Subscribed share capital-OS (18,000 shares x P1) 18,000

Share capital-OS 18,000
Subscribed share capital-OS (3,000 shares x
P1) 3,000
Share premium-EOP [3,000 shares x (P26 -
P1)] 75,000
Subscriptions receivable (3,000 x P26 x 50%) 39,000
Share premium - forfeited subscriptions 39,000

4/30 Retained earnings (at fair value) 950,000

Property dividends payable 950,000

8/30 Cash (3,000 x P20) 60,000

Retained earnings 12,000
Treasury shares (3,000 x
P24) 72,000

9/14 Cash (945 x 10 x P10) 94,500

Share premium-warrants (945/1,200 x
P36,000) 28,350
Share capital-OS (945 x 10 x P1) 9,450
Share premium-EOP 113,400
11/3
0 Retained earnings 1,290,900

4
 1,290,90
Dividends payable - OS 0

Ordinary shares issued and outstanding, 1/1 600,000

Shares issued, 1/6 22,500
Shares issued, 3/15 18,000
Shares issued, 9/14 9,450

Number of shares issued, 12/31 649,950

Treasury shares (7,500 - 3,000) (4,500)

Number of shares issued and outstanding 645,450

Dividends per share 2.00

Total dividends 1,290,900

12/1 Retained earnings (900,000 x
5 6%) 54,000
Dividends payable - PS 54,000

1/8 Retained earnings 19,500

Income tax payable (480,000/8 x 1/2 x 35%) 10,500
Accumulated depreciation (480,000/8 x 1/2 ) 30,000
12/3
1 P/L summary 2,585,650
2,585,65
Retained earnings 0
12/3 Retained earnings -
1 unappropriated 108,000
Retained earnings - appropriated (cost of TS) 108,000

PROBLEM NO. 3 - Audit of equity transactions and balances

SOLUTION:

Requirement no. 1

5
01/0
2 Share capital [50,000 shares (P120-P100)] 1,000,000
Share premium 1,000,000

08/3
0 Treasury shares 550,000
Share capital 550,000

12/0
1 Retained earnings 287,500
Treasury shares (2,500 shares x P110) 275,000
Share premium 12,500

12/2
9 Retained earnings (P617,500 - P545,000) 72,500
Share capital 545,000
Share dividends distributable (4,750 x P100) 475,000
Share premium 142,500

Shares issued 50,000

Treasury shares (5,000 -2, 500) (2,500)

Shares outstanding 47,500

Dividend rate (small share dividend) 10%

Shares to be issued 4,750

Market value per share 130

Total amount to be charged to RE 617,500

Total par value of stock dividend payable 475,000

Share premium 142,500

12/3
1 Retained earnings (2,500 shares x P110) 275,000
Retained earnings appropriated for treasury shares 275,000

Requirement no. 2

6
 5,000,00
Share capital (P5,995,000-P1,000,000+P550,000-P545,000) 0
Share dividends distributable 475,000
1,155,00
Share premium (P1,000,000+P12,500+P142,500) 0
Retained earnings-appropriated 275,000
3,382,50
Retained earnings (P3,742,500-P287,500-P72,500-P275,000) 3,107,500 0

Treasury shares (P550,000-P275,000) (275,000)

Total equity 9,737,500

PROBLEM NO. 4 - Audit of retained earnings

SOLUTION:

a Profit or loss (Other expense) 5,250

Retained earnings 5,250

b Profit or loss (Other expense) 52,500

Retained earnings 52,500

d Profit or loss (Other expense) 48,300

Retained earnings 48,300

g Retained earnings 129,500

Share premium 129,500

h Share premium 10,000

Retained earnings 10,000

i Retained earnings 8,470

Share premium 8,470

j Retained earnings 25,900

Share premium 25,900

7
k Retained earnings 15,050
Profit or loss (Other income) 15,050

l Retained earnings 10,500

Profit or loss (Other income) 10,500

q Retained earnings 40,000

Share premium 40,000

r Retained earnings 250,000

Revaluation surplus 250,000

Unadjusted retained earnings balance 559,320

a 5,250
b 52,500
d 48,300
g (129,500)
h 10,000
i (8,470)
j (25,900)
k (15,050)
l (10,500)
q (40,000)
r (250,000)

Correct amount of RE before closing profit or loss 195,950

Alternative computation:
Jan.
1 Balance 726,400
c Share dividend (140,000)

8
 e Officers’ compensation related to income
of prior periods – accrual overlooked (325,500)
f Loss on retirement of preferred shares
at more than issue price (70,000)
m Correction of prior-period error 50,050
n Effect of change in accounting principle
from FIFO to weighted average 100,000
o Dividends payable (25,000)
p Loss on sale of treasury stock (20,000)
s Appropriated for property acquisition (100,000)

Correct amount of RE before closing profit or loss 195,950

PROBLEM NO. 5 - Audit of equity transactions and balances

SOLUTION:

Requirement no. 1
RE
2010 2011 2012
12.31.12
Unadjusted profit (loss) (175,000) 220,000 409,300 454,300
Depreciation expense (15,000) (17,000) (23,000) (55,000)
Miscellaneous expense (20,000) (25,000) (5,000) (50,000)
Land write-up (100,000) (100,000)
Adjusted profit (loss) (210,000) 78,000 381,300 249,300

Requirement no. 2
Shareholders equity 1,850,000
Treasury shares 4,900
Loans receivable 100,000

9
 Share capital 1,010,000
Share premium – EOP 595,000
Share premium – TS 600
Land 100,000
Retained earnings 249,300

Requirement no. 3
Share capital 1,010,000
Share premium – EOP 595,000
Share premium – TS 600
Retained earnings 249,300
Treasury shares (4,900)

Total equity 1,850,000

PROBLEM NO. 6 - Audit of equity-settled share-based payment

SOLUTION:

Year Computation Comp. Exp. Cumulative

1 80 × 200 options ×P20 × 1/3 106,667 106,667
2 (85 × 300 options ×P20 × 2/3) – P106,667 233,333 340,000
3 (86 × 300 options ×P20 × 3/3) – P233,333 176,000 516,000

PROBLEM NO. 7 - Audit of cash-settled share-based payment

SOLUTION:

Yea
r Computation Expense Liability
1 405 × 100 SARs × P14.40 × 1/3 194,400 194,400

10
 2 400 × 100 SARs × P15.50 × 2/3 - P194,400 218,933 413,333
3 253 × 100 SARs × P18.20 × 3/3 - P413,333 47,127 460,460
150 × 100 SARs × P15.00 225,000 272,127

4 113 × 100 SARs × P21.40 - P460,460 (218,640) 241,820

140 × 100 SARs × P20.00 280,000 61,360

5 0 - P241,820 (241,820) -
113 × 100 SARs × P25.00 282,500 40,680

PROBLEM NO. 8 - Audit of cash or equity settled share-based payment

SOLUTION:

The fair value of the equity alternative is P57,600 (1,200 shares × P48). The fair value of the cash
alternative is P50,000 (1,000 phantom shares × P50). Therefore, the fair value of the equity
component of the compound instrument is P7,600 (P57,600 – P50,000).

Yea
r Computation Expense Equity Liability
1 Equity component (P7,600 × 1/3) 2,533 2,533
Liability component (1,000 × P52 × 1/3) 17,333   17,333

Total 19,866 2,533 17,333

2 Equity component (P7,600 × 1/3) 2,533 2,533

Liability component [(1,000 × P55 × 2/3)-P17,333] 19,334   19,334

Total 21,867 5,066 36,667

3 Equity component (P7,600 - P5,066) 2,534 2,534

Liability component [(1,000 × P60 × 3/3)-P36,667] 23,333   23,333

Total 25,867 7,600 60,000

Scenario 1: cash of P60,000 paid (60,000)

Scenario 1 totals 67,600 7,600 -
Scenario 2: 1,200 shares issued 60,000 (60,000)

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 Scenario 2 totals 67,600 67,600 -

PROBLEM NO. 9 - Book value per share

SOLUTION:

Requirement No. 1
Excess
Preferenc
over par e Ordinary

*
Balances 1,069,600 340,000 800,000
PS dividend (P340,000 x 6%) (20,400) 20,400
PS liquidation premium (3,400 x
P15) (51,000) 51,000

Balance to OS 998,200   998,200

1,798,20
Total 411,400 0
Divide by outstanding shares 3,400 8,000

Book value per share 121.00 224.78

Computation of "excess over

par"
Total equity 2,209,600
Outstanding par value of PS* (340,000)
Outstanding par value of OS (800,000)

1,069,600

Details of "excess over par"

150,000
Premium on PS

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 165,000
Premium on OS
Retained earnings, appropiated - bond
retirement 320,000
Retained earnings, unappropiated 458,600
Excess of cost of TS over par (P84,000 -
P60,000) (24,000)

Excess over par 1,069,600

Note: For computation of BV/share purposes, TS is treated as a retired
stock.

Shares Amount

*
PS issued 4,000 400,000
Treasury PS, at par (600 x P100) (600) (60,000)

Outstanding PS 3,400 340,000

Requirement No. 2
Excess
Preferenc
over par e Ordinary

*
Balances 1,069,600 340,000 800,000
PS dividend (P340,000 x 6%) (20,400) 20,400
PS liquidation premium (3,400 x
P15) (51,000) 51,000
OS dividend (P800,000 x 6%) (48,000) 48,000

Balance for participation 950,200

Preference (340/1,140 x P950,200) 283,393

Ordinary (800/1,140 x P950,200)   666,807
1,514,80
Total 694,793 7
Divide by outstanding shares 3,400 8,000

Book value per share 204.35 189.35

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PROBLEM NO. 10 - Earnings per share

SOLUTION:

Profit to OS WA Outs. OS EPS

a
Basic 1,020,000 600,000 1.70
)
Exercise of b
- 10,000
options )
1,020,000 610,000 1.67
c
Bond conversion 96,000 80,000
)
1,116,000 690,000 1.62
d e
PS conversion 180,000 90,000
) )
1,296,000 780,000 1.66

Notes:

a
) Profit for the year 1,200,000
PS dividend (P3M x .06) (180,000)

1,020,000

b
) Shares to be issued on exercise 50,000
Assumed TS acquired [(50,000 x
P20)/P25] (40,000)

10,000

c Net interest savings on bond

) conversion
(P2M x .08 x .6) 96,000

14
 d
) PS dividend (P3M x .06) 180,000

e
) Shares to issued on PS conversion
(P3M/P100 x
3) 90,000

PROBLEM NO. 11 - Earnings per share

SOLUTION:

Computation of basic EPS:

Profit for 2012 13,550,000
Less PS dividends:
March 31 (700,000 shares x P.75) 525,000
6/30, 9/30 & 12/31 (500,000 shares x P.75 x 3) 1,125,000 1,650,000

Profit to OS 11,900,000
/WA outstanding OS (see below) 6,736,000

Basic EPS 1.77

Computation of WA outstanding OS:

Date Adj. shares Mos. O/S W.A
1/1/12 (3,000,000 x 1.05 x 2) 6,300,000 12/12 6,300,000
4/1/12 (200,000 x 1.05 x 2) 420,000 9/12 315,000
8/1/12 300,000 5/12 125,000
11/1/12 (24,000) 2/12 (4,000)

6,736,000

Computation of diluted EPS:

Profit to OS 11,900,000

15
 Add PS dividends:
March 31 (700,000 shares x P.75) 525,000
6/30, 9/30 & 12/31 (500,000 shares x P.75 x 3) 1,125,000 1,650,000
Profit to OS 13,550,000
/WA outstanding OS (see below) 7,891,000

Diluted EPS 1.72

Computation of WA outstanding OS:

Number of shares to compute basic EPS 6,736,000
Convertible PS still outstanding (500,000 x 1.05 x 2) 1,050,000
Convertible PS converted (200,000 x 1.05 x 2 x 3/12) 105,000

Number of shares to compute diluted EPS 7,891,000

PROBLEM NO. 12 - Analysis equity transactions including EPS computation

SOLUTION:

Requirement No. 1-3

Share
premium RE Total equity
2011
Issued 100,000 ordinary shares at P27 2,600,000 2,700,000
Profit 250,000 250,000
Dividends   (28,000) (28,000)

Balances, 12/31/11 2,600,000 222,000 2,922,000

2012
1/2/12 - Issued 10,000 PS at par 1,000,000
3/1/12 - Issued 3,000 OS for legal services 93,000 96,000
7/1/12 - Issued 40,000 OS at P42 1,640,000 1,680,000

16
 10/1/12 - Repurchased 16,000 TS at P34 (544,000)
12/1/12 - Reissuance of 3,000 TS at P29 (15,000) 87,000
12/30/12 - PS dividend (P1M x .06) (60,000) (60,000)
'- OS dividend (130T x P.20) (26,000) (26,000)
Profit   380,000 380,000

Balances, 12/31/12 4,333,000 501,000 5,535,000

(1) (2) (3)

Requirement No. 4
Profit for 2012 380,000
Less PS dividend for 2012 60,000

Profit to OS 320,000
Divide by the WA outstanding OS (see
below) 118,750

Basic EPS for 2012 2.69

Computation of WA outstanding OS:

Shares Time O/S WA
1/1/12 100,000 12/12 100,000
3/1/12 3,000 10/12 2,500
7/1/12 40,000 6/12 20,000
10/1/12 (16,000) 3/12 (4,000)
12/1/12 3,000 1/12 250

118,750

Requirement No. 5
Profit to OS (see no. 4) 320,000
Add PS dividend for 2012 60,000

Adjusted profit to OS 380,000

17
 Divide by the WA outstanding OS:
Actual (see no. 4) 118,750
Potential (10,000 x 5) 50,000 168,750

Diluted EPS for 2012 2.25

PROBLEM NO. 13 - Analysis equity transactions including EPS computation

SOLUTION:

Requirement No. 1
Ordinary shares outstanding, 12/31/11 (P1,598,400/P20) 79,920
Shares issued 2/1/12 2,200

82,120
Share split, 5/31/12 x 2

164,240
Treasury shares acquired, 9/1/12 (1,000)

Ordinary shares outstanding, 10/1/12 163,240

x Dividend per share 4

Dividends paid to ordinary shareholders 652,960

Requirement No. 2
Retained earnings, 12/31/11 1,585,840
Profit for 2012 991,520
Dividends - ordinary (see no. 36) (652,960)
Dividends - preference [(P270,000 + P60,000) x .12] (39,600)

Retained earnings, 12/31/12 1,884,800

Requirement No. 3
Total equity, 12/31/11 3,729,440

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 Add (deduct) 2012 transactions:
2/1 - Issuance of OS (2,200 x P30) 66,000
5/1 - Issuance of PS (600 x P128) 76,800
5/31 - share split -
9/1 - Acquisition of TS (1,000 x P18) (18,000)
10/1 - PS dividend (see no. 37) (39,600)
- OS dividend (see no. 37) (652,960)
11/1 - Re-issuance of TS (1,000 x P22) 22,000
Profit for 2012 991,520

Total equity, 12/31/12 4,175,200

Requirement No. 4
Profit for 2011 1,345,040
Less PS dividend (270,000 x 12%) 32,400

Profit to OS 1,312,640
Divide by weighted average number of OS (see below) 153,360

Basic earnings per share - 2011 8.56

Computation of weighted average number of OS

Adjusted
shares Fraction Total
Jan. 1 (65,000 x 1.08* x 2**) 140,400 12/12 140,400
May 1 (9,000 x 1.08* x 2**) 19,440 8/12 12,960

Total 153,360

*Share dividend, 7.31.11

**2-for-1 share split, 5.31.12

Requirement No. 5
Profit for 2012 991,520

19
 Less PS dividend (P330,000 x 12%) 39,600

Profit to OS 951,920
Divide by weighted average number of OS (see below) 163,707

Basic earnings per share - 2012 5.81

Computation of weighted average number of OS

Adjusted
shares Fraction Total
Jan. 1 (79,920 x 2*) 159,840 12/12 159,840
Feb. 1 (2,200 x 2*) 4,400 11/12 4,033
Sept. 1 (1,000) 4/12 (333)
Nov. 1 1,000 2/12 167

Total 163,707
PROBLEM NO. 14 - Theory

Select the best answer for each of the following:

1. In an examination of shareholder’s equity, an auditor is most concerned that

a. Capital stock transactions are properly authorized.
b. Stock splits are capitalized at par or stated value on the dividend declarations date.
c. Dividends during the year under audit were approved by the shareholders.
d. Changes in the accounts are verified by a bank serving as a registrar and stock
transfer agent.

2. In audit of a medium-sized manufacturing concern, which one of the following areas can
be expected to require the least amount of audit time?
a. Owner’s equity
b. Assets
c. Revenue
d. Liabilities

3. When corporate client maintains its own stock records, the auditor primarily will rely
upon
a. Confirmation with the company secretary of shares outstanding at year-end.
b. Review of the corporate minutes for data as to shares outstanding.
c. Confirmation of the number of shares outstanding at year-end with the appropriate
state official.
d. Inspection of the stock book at year-end and accounting for all certificate numbers.

20
4. When a client company does not maintain its own share records, the auditor should
obtain written confirmation from the transfer agent and registrar concerning
a. Restrictions on the payment of dividends.
b. The number of shares issued and outstanding.
c. Guarantees of preferred stock liquidation value.
d. The number of shares subject to agreement to repurchase.

5. The auditor is concerned with establishing that dividends are paid to client corporation
shareholders owning shares of the
a. Issue date
b. Record date
c. Declaration date
d. Payment date

6. An audit program for the retained earnings account should include a step that requires
verification of the
a. Fair value used to charge retained earnings to account for a two-for-one share split.
b. Approval of the adjustment to the beginning balance as a result of a write-down of an
account receivable.
c. Authorization for both cash and share dividends.
d. Gain or loss resulting from disposition of treasury shares.

7. During an audit of an entity’s shareholders’ equity accounts, the auditor determines

whether there are restrictions on retained earnings resulting from loans, agreements, or
law. This audit procedure most likely is intended to verify management’s assertion of
a. Existence
b. Valuation
c. Completeness
d. Presentation and disclosure

8. If the auditee has a material amount of treasury shares on hand at year-end, the auditor
should
a. Count the certificates at the same time other securities are counted.
b. Count the certificates only if the company had treasury share transactions during the
year.
c. Not count the certificates if treasury share is a deduction from shareholders’ equity
d. Count the certificates only if the company classifies treasury shares with other assets.

9. In performing tests concerning the granting of stock options, an auditor should

a. Confirm the transaction with the Securities and Exchange Commission.
b. Verify the existence of option holders in the entity’s payroll records or stock ledgers.
c. Determine that sufficient treasury stock is available to cover any new stock issued.
d. Trace the authorization for the transaction to a vote of the board of directors.

10. The auditor would not expect the client to debit retained earnings for which of the
following transactions?

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 a. A 4-for-1 share split.
b. “Loss” resulting from disposition of treasury shares.
c. A 1-for-10 share dividend.
d. Correction of error affecting prior year’s earnings.

ANSWER:
1. A 5. B 9. D
2. A 6. C 10. A
3. D 7. D
4. B 8. A

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