Retained Earnings

Problem 1
Rachaba Company reported the following balances of shareholders’ equity on January 1, 2020.
Share Capital, 30,000 shares issued and outstanding 3,000,000
Share Premium 4,500,000
Retained Earnings 2,250,000
On May 1, 2020, Rachaba Company, as a consideration to the outstanding performance of the
company, issued 6,000 share dividends with P100 par value to its shareholders. During the date of
declaration, the market value of the share was P125 per share.
The share dividend was issued on July 31, 2020, during which the market value of the share was
P150 per share.
What is the retained earnings balance immediately after the share dividend?

Solution:
The first question here is, how much retained earnings should be capitalized?
First, to know how much retained earnings should be capitalized, determine whether the share
dividend is small or large, that is, if it is greater than or equal (>/=) or less than (<) 20%.
6,000 share dividend issued out of 30,000 shares outstanding
6,000 ÷ 30,000 = 20% ➡️Should be capitalized at par or stated value
6,000 × P100 par value = 600,000
To record the declaration of the dividend:
Retained Earnings 600,000
Share Dividends Payable 600,000
The retained earnings balance would be:
Retained Earnings, Jan 1 2,250,000
(600,000)
1,650,000

Problem 2
The board of directors of Mekeni Company have decided to issue share dividends to boost the
confidence of its shareholders towards the company. The share capital of the company has a par
value of P30 and is currently selling at P45 per share.
During the year, the company, which has an authorization for 850,000 shares, had issued 750,000
shares, 150,000 of which is held in treasury.
After the issuance of the share dividend, the entity capitalized P2,160,000 of the retained earnings
balance.
What percentage was declared as a share dividend by the directors?

Solution:
From the given problem above, we can derive the following amounts:
 P30 par value
 P45 market value
 600,000 shares outstanding
 150,000 treasury shares
The entity capitalized P2,160,000 of the retained earnings balance.
First, let us suppose the share dividend percentage declared is <20%
We know that if the share dividend issued is <20% of the total outstanding shares, it is
capitalized at market or fair value. Therefore:
2,160,000 ÷ P45 market value (<20%) = 48,000 share dividend issued
48,000 ÷ 600,000 = 0.08 or 8%
Now, let us check if P30 par value will result to 20% or more share dividend percentage.
2,160,000 ÷ P30 par value (>/= 20%) = 72,000
72,000 ÷ 600,000 = 0.12 or 12%
It does not result to 20% or more, therefore the retained earnings is capitalized at market
or fair value, and the percentage is 0.08 or 8%.

Problem 3
Dyeniper Company reported the following balances of shareholders’equity on January 1, 2020:
Share Capital, 300,000 shares issued and outstanding 4,500,000
Share Premium 2,000,000
Retained Earnings 10,000,000
The directors of Dyeniper Company declared a 10% share dividend on February 1, 2020, during
which the market value of the share was P40. The share dividend was issued on April 30, 2020
when the market value of the share was P55.
On June 1, 2020, Dyeniper Company issued 60,000 shares as share dividend, which has a market
value of P30 per share before the date of declaration.
The entity incurred a net loss of 1,500,000 for the period as a result of poor managerial process and
lack of security measures.
What amount should be reported as retained earnings on December 31, 2020?

Solution:
First, let’s account for the dividend declaration on February 1, 2020
300,000 shares outstanding × 10% = 30,000 share dividend issued
30,000 × P40 market value (<20%) = P1,200,000
P4,500,000 ÷ 300,000 shares outstanding = P15 par value per share
30,000 × P15 par value = P450,000
To record the declaration of the dividend:
February 1 Retained Earnings 1,200,000
Share Dividends Payable 450,000
Share Premium 750,000
Then, let’s account for the June 1, 2020 dividend declaration.
To know how much retained earnings should be capitalized, let’s compute what percentage was
declared as a share dividend by the directors.
60,000 shares issued ÷ 300,000 shares outstanding = 20%
Therefore, we will capitalized it at par value:
60,000 × P15 = P900,000
Retained Earnings 900,000
Share Dividends Payable 900,000
To compute for the retained earnings balance on December 31, 2020
Retained Earnings, January 1 10,000,000
February 1 (1,200,000)
June 1 (900,000)
Net loss for the year (1,500,000)
Retained Earnings, December 31 6,400,000

Problem 4
Balasa Company disclosed the following amounts of shareholders’ equity on January 1, 2020:
 Share Capital, 100,000 shares authorized,
80,000 shares issued, at P50 par 4,000,000
Share Premium 800,000
Retained Earnings 2,225,000
During the year, the entity had the following transactions:
1. The entity found out that the machinery used in the production is under-depreciated. The
cost of the equipment on date of purchase is P550,000, and has an accumulated
depreciation of P220,000. The equipment has a useful life of 10 years and is utilized by the
company for five years as of 2019.
2. The entity sold 150 units of product A, the cost of each is P280, for P350 per unit.
3. The entity declared cash dividends equivalent to P240,000.
4. Due to some unexpected turn of events, the management decided to change its accounting
policy which resulted to an increase in inventory valuation of 250,000.
Determine the retained earnings balance on December 31, 2020.

Solution:
2020
Retained Earnings, January 1 2,225,000
Correction of error from prior
year under-depreciation (55,000)
Corrected beginning balance 2,170,000
Net Income [150 × (350 - 280)] 10,500
Dividends declared during the year (240,000)
Change in accounting policy resulting
to an increase in inventory 250,000
Retained Earnings, December 31 2,190,500

Problem 5
The following amounts are reported in the statement of financial position of Mimiko Company on
December 31, 2020:
Cash 2,950,000
Inventory 1,500,000
Property, Plant and Equipment 2,750,000
Accumulated Depreciation ( 350,000)
6,850,000

Liabilities 3,810,000
Share capital, 85,000 shares, P45 par 3,825,000
Retained Earnings (Deficit) ( 785,000)
6,850,000
On December 31, the owners of the company together with its creditors agreed that the company
needs to undergo a quasi-reorganization. The following restatements should be made:
1. The inventory is overvalued by P150,000 and shall be revalued accordingly.
2. The property, plant and equipment shall be recorded at its fair value which is P2,125,000.
3. The share capital is reduced to 36,250 shares, P40 par value, which is now equivalent to
P1,450,000.
4. The resulting deficit from the reorganization is to be offset to share premium.
Prepare the journal entries to record the effects pf the reorganization on December 31, 2020 and
prepare a statement of financial position presenting the balances after the reorganization.

Solution:
Adjustments

 Retained Earnings 150,000

Inventory 150,000
 Accumulated Depreciation 350,000
Retained Earnings 275,000
Property, Plant and Equipment 625,000
 Share Capital 2,375,000
Share Premium 2,375,000
 Share Premium 1,165,000
Retained Earnings 1,165,000
Statement of Financial Position
December 31, 2017
Assets
Cash 2,950,000
Inventory 1,350,000
Property, Plant and Equipment 2,125,000
6,425,000
Liabilities and Shareholder’s Equity
Liabilities 3,810,000
Share Capital, 36,250 shares, P40 par 1,450,000
Share Premium 1,165,000
6,425,000

Share-Based Compensation – Problems

Problem 1
On January 1, 2020, Meryam Company decided to grant 300 share options to each of the 100 top
performing employees of the company for the previous year 2019. The options are intended to
compensate the employees for the substantial increase in the productivity of the company for the
last two years.
The share options are exercisable at the end of a two-year vesting period provided the grantees will
remain under the company’s employ during this vesting period.
The market price of the share at the date of grant was P50. The fair value of the share option is P35.
The option will expire a year after the end of the vesting period.
All 100 employees remained in the entity’s employ during 2020, but at the end of the year 2021, 17
employees left the company.
The exercise price is P75 and the par value per share is P60.
All shares options are exercised by the grantees on January 1, 2022.
Compute for the compensation expense for 2020 and 2021, and prepare the journal entries to
record the share options each year and the exercise of the share options.

Solution:

The compensation expense for each year of the two-year vesting period is computed as follows:

For 2020
Employees entitled to share options 100
Multiply by share options per employee 300
Total share options 30,000
Multiply by fair value 35
Total compensation 1,050,000
Compensation expense for 2020 (1,050,000/2) 525,000

The journal entry would be:

Dec. 31 Salaries – Share Options 525,000
Share Options Outstanding 525,000

For 2021
Number of employees 100
Employees who left in 2021 ( 17)
Employees entitled to share options 83
Multiply by share options per employee 300
Total share options 24,900
Multiply by fair value 35
Total compensation 871,500
Compensation recognized in 2020 (525,000)
Compensation expense in 2021 346,500

The journal entry would be:

Dec. 31 Salaries – Share Options 346,500
Share Options Outstanding 346,500
To record the exercise of the share options:
Jan 1 Cash (24,900 shares × P75) 1,250,000
Share Options Outstanding 871,500
Ordinary Share Capital (24,900 × P60) 1,494,000
Share Premium 627,500

Problem 2
Missu Company decided to issue 700 share options to five executives in lieu of their many years of
service to the company. The share options can be exercised on December 31, 2023 after a three
year vesting period, and will expire a year after.
The option price is P150 and they were granted on a date when the value of the shares was
estimated to be at P125 per share.
The fair value of the share options on the vesting date has been determined reliably at P1,250,000.
Because of excitement, the entity has decided to settle the award earlier than planned.
The compensation expense charged in the income statement since the date of grant are as follows:
2021 350,000
2022 400,000
The entity settle the award on December 31,2022 and paid P1,200,000.
Prepare the journal entry to record the cash payment for the settlement of the share options

Solution:
2021 350,000
2022 400,000
750,000
The journal entry to record the settlement:
Dec 31 Share Options Outstanding 750,000
Salaries 450,000
Cash 1,200,000
Problem 3
On January 1, 2020, Tabir Company established an employee share option plan which will be based
on the employees' performance for the next two years. The plan allows the grantees, equivalent to
25 employees, to acquire 2,000 shares at P65 per share if their performance will result to a 15%
increase in net income for the financial year 2020 and 2021, base on the net income of the previous
year. If they fail to comply with this condition, they will be entitled to 1,500 shares options only.
At the date of grant, the shares are selling at P100 per share and has a par value of P45. The fair
value of the share option is P25 during this same date.
The entity reported the following net income each year:
2019 3,800,000
2020 4,500,000
2021 5,100,000
2022 6,700,000
Determine the compensation expense to be recognized for 2020 and 2021, and the amount of share
premium to be recognized in the exercise of the share options.

Solution:
3,800,000 × 115% = 4,370,000
Therefore, the employees are entitled to 2,000 share options each.

Computation of Compensation Expense

2020
Number of employees 25
Multiply by share options per employee 2,000
Total share options 50,000
Multiply by fair value 25
Total compensation 1,250,000
Compensation expense for 2020 (1,250,000 / 2 years) 625,000

Dec. 31 Salaries – Share Options 625,000

Share Options Outstanding 625,000
 4,500,000 × 115% = 5,175,000
Therefore, the employees are entitled to 1,500 share options each only.

Computation of Compensation Expense

2021
Number of employees 25
Multiply by share options per employee 1,500
Total share options 37,500
Multiply by fair value 25
Cumulative compensation – December 31, 2021 937,500
Cumulative compensation – December 31, 2020 625,000
Compensation expense for 2021 312,500

Dec. 31 Salaries – Share Options 312,500

Share Options Outstanding 312,500

To record the exercise of the share options:

Jan 1 Cash (37,500 shares × P65) 2,437,500
Share Options Outstanding 937,500
Ordinary Share Capital (37,500 × P45) 1,687,500
Share Premium 1,687,500

Problem 4
Sylvestre Company granted Mr. Crocker 600 share appreciation rights on January 1, 2020. The
entity values the faces of its managers and they deemed that Mr. Crocker's handsome face is a big
contribution to the success of the company.
The rights are due to vest after a three-year vesting period, after which he is entitled to receive cash
equal to the appreciation of the share price over the market value of the share on January 1, 2020.
The share prices are as follows:
January 1, 2020 150
December 31, 2020 170
December 31, 2021 200
December 31, 2022 225

The share appreciation rights were exercised on February 1, 2023.

Prepare the journal entries in connection to the share appreciation rights.
Solution:

2020
Market value on December 31, 2020 170
Predetermined price on January 1, 2020 150
Excess 20
Multiply by number of shares 600
Total compensation 12,000
Compensation for 2020 (12,000 / 3 years) 4,000

Dec. 31 Salaries 4,000

Accrued Salaries Payable 4,000

2021
Market value on December 31, 2021 200
Predetermined price 150
Excess 50
Multiply by number of shares 600
Cumulative compensation . 30,000
Accrued compensation on December 31, 2021
(30,000 / 3 × 2 years) 20,000
Accrued compensation on December 31, 2020 ( 4,000)
Compensation Expense for 2021 16,000

Dec. 31 Salaries 16,000

Accrued Salaries Payable 16,000

2022
Market value on December 31, 2022 225
Predetermined price 150
Excess 75
Multiply by number of shares 600
Accrued compensation on December 31, 2022 45,000
Accrued compensation on December 31, 2021 ( 20,000)
Compensation Expense for 2022 25,000

Dec. 31 Salaries 25,000

 Accrued Salaries Payable 25,000

2023
Feb. 1 To settle the share appreciation right:
Accrued Salaries Payable 45,000
Cash 45,000

Problem 5
On January 1, 2020, Armado Company offered 1,000 share appreciation rights to each of the 165
employees under the finance department with a predetermined price of P350 per share. The share
appreciation rights are exercisable on January 1, 2022 after a two-year vesting period. The
employees are entitled to receive cash equal to the excess of the share prices over the
predetermined price on January 1, 2020.
The quoted prices of these shares are as follows:
January 1, 2020 280
December 31, 2020 300
December 31, 2021 280
December 31, 2022 310

Determine the compensation expense to be recognized each year as a result of the appreciation
rights. Prepare the journal entries to recognize each compensation, including the exercise of the
share appreciation rights.

Solution:

2020
Market value on December 31, 2020 300
Predetermined price on January 1, 2020 280
Excess 20
Multiply by number of shares
(1,000 × 165 employees) 165,000
Total compensation 3,300,000
Compensation for 2020 (3,300,000 / 2 years) 1,650,000

Dec. 31 Salaries 1,650,000

Accrued Salaries Payable 1,650,000

The market value of the shares unfortunately dropped to P280 on 2021. Therefore, there is no
appreciation or increase in market value since our predetermined price is P280.
The journal entry to reverse the accrued compensation is:
2021
Dec. 31 Accrued Salaries Payable 1,650,000
Gain on reversal of share appreciation right 1,650,000

Basic Earnings per Share – Problems

Problem 1
Aryelsebenpipti Company had the following ordinary share activity during 2020:
Date Shares
January 1 Shares issued and outstanding 250,000
March 31 New shares issued 75,000
June 30 Share Split 3 for 1
August 1 Treasury shares acquired 50,0000
November 1 Declared 30% share dividend

Compute for the average ordinary shares outstanding.

Solution:

Computation

(a) (b) (a × b)
Date Shares Months outstanding Peso months
January 1 975,000 12 11,700,000
April 30 292,000 8 2,336,000
August 31 (650,000) 4 ( 2,600,000)
11,436,000

Average Shares (11,436,000 / 12) 953,000

Shares
January 1 (250,000 × 3 × 1.30) 975,000
March 1 ( 75,000 × 3 × 1.30) 292,000
August 1 ( 50,000 × 1.30 ) ( 65,000)
Problem 2

Cheribumbum Company provided the following information for the current year 2020:

Preference share capital, P85 par, 15% cumulative 5,000,000

Ordinary share capital, P80 par, 50,000 shares 4,000,000

2020 Income from continuing operations 2,800,000

2021 Income from continuing operations 3,400,000
2020 Income from discontinuing operations 350,000
2021 Income from discontinuing operations 240,000

Determine the basic earnings per share for the year 2020.

Solution:

Income from continuing operations 2,800,000

Preference dividend for current year (20% × 5,000,000) ( 1,000,000)
Income to ordinary share 1,800,000

Income from continuing operations

(1,800,000 ÷ 50,000 shares) 36

Income from discontinued operation

(350,000 ÷ 50,000 shares) 7

43

Problem 3

On March 1, 2020, Pilerka Company carried out a bonus issue of ordinary shares in the ratio of
three ordinary shares for each original ordinary share outstanding. Pilerka Company reported the
following amounts:

Net Income for 2019 3,240,000

Net Income for 2020 4,320,000

The shareholders' equity at the current year-end showed the following information:

Preference share capital, 10%

cumulative, P120 par 3,450,000
Ordinary share capital, P80 par,
55,000 shares outstanding 4,400,000

The shareholders' equity at the beginning of the prior period had the following information:

Preference share capital, 10%

 cumulative, P120 par 3,180,000
Ordinary share capital, P80 par
45,000 shares outstanding 3,600,000

Compute for the basic earnings per share.

Solution:

Ordinary shares outstanding – January 1, 2019 45,000

Bonus issue on March 1, 2020 (45,000 × 3) 135,000
Total ordinary shares outstanding 180,000

Basic Earnings per Share

2019 (3,240,000 / 180,000) 18

2020 (4,320,000 / 180,000) 24

The bonus issue is accounted for as if it occurred at the beginning of the previous year 2019.

Problem 4
Marimar Company had the following ordinary share transactions for the current year:
Date
February 1 Beginning balance of 75,000 shares, P60 par
May 31 Issued additional 15,000 shares
July 31 Declared 50% share dividends
September 1 Share split of 4 is to 1
November 30 Purchased 24,000 shares to be held as treasury

Compute for the average ordinary shares outstanding.

Solution:

Computation

(a) (b) (a × b)
Date Shares Months outstanding Peso months
March 1 450,000 10 4,500,000
May 31 90,000 7 630,000
November 30 ( 24,000) 1 ( 24,000)
5,106,000

Average Shares (5,106,000 / 12) 425,500

Shares
February 1 (75,000 × 1.50 × 4) 450,000
May 1 (15,000 × 1.50 × 4) 90,000
November 1 (24,000) ( 24,000)

Problem 5

Honeypie Company had the following capital structure for the year 2020:

Preference share capital, P75 par 4,650,000

Ordinary share capital, P60 par, 65,000 shares 3,900,000

During the year, the entity earned P2,100,000 income from the main operations of the business.
Unfortunately, due to some unexpected turn of events, the entity was forced to stop its operations
in Cagayan, and was able to earn only P715,000.

If the entity reported P18 and P11 income from continuing operations and discontinued operation
respectively, determine the percentage at which preference share dividend is issued cumulatively.

Solution:

18 × 65,000 shares = 1,170,000 income to ordinary share

Income from continuing operations 2,100,000

Income to ordinary share (1,170,000)
Preference dividend for current year 930,000

930,000 ÷ 4,650,000 = 0.20 or 20%

To check:

Income from continuing operations 2,100,000

Preference dividend for current year (20% × 4,650,000) ( 930,000)
Income to ordinary share 1,170,000

Income from continuing operations

(1,170,000 ÷ 65,000 shares) 18

Income from discontinued operation

(715,000 ÷ 65,000 shares) 11

29
Diluted Earnings per Share - Problems

Problem 1

At the beginning of the current year, the capital structure of Birgoso Company consists of
P12,000,000 ordinary share capital, 380,000 shares authorized and 300,000 shares issued and
outstanding. The par value of the shares is P40.

On June 30 of the current year, Birgoso Company issued a 15%, P6,000,000 convertible bonds, each
P3,000 bond can be converted into 5 ordinary shares.

The entity had made a net income of P7,500,000 for the year attributable to ordinary shareholders.

The income tax rate is 30%.

The securities are outstanding during the entire year.

Compute for the basic earnings per share and diluted earnings per share for the year.

Solution:

Basic Earnings per share

Net income 7,500,000
Divide by ordinary shares actually outstanding 300,000
Basic earnings per share 25

Diluted earnings per share

Net income 7,500,000
Add: Interest expense on bonds payable
(6,000,000 × 15% × 6/12) 450,000
Income tax (30% × 450,000) (135,000) 315,000
Adjusted net income 7,815,000
Ordinary shares actually outstanding 300,000
Assumed issued ordinary shares through
conversion of bonds payable (2,000 × 5 × 6/12) 5,000
Total shares outstanding 305,000
Diluted Earnings per Share (7,815,000 ÷ 305,000) 25.62

Problem 2
Paloma Company had the following share capital outstanding at the beginning of the current
period:
Ordinary share capital, 430,000 shares authorized,
280,000 shares issued and outstanding, P30 par 8,400,000
Preference share capital – 20%, 30,000 shares,
P80 par, cumulative and one preference share
can be converted into three ordinary shares 2,400,000

Paloma Company’s net income for the year is P4,000,000.

All the preference shares were converted into ordinary shares on November 1 of the current year.

The entity declares preference share dividends every six months.

Compute for the basic earnings per share and diluted earnings per share for the year.

Solution:

Basic Earnings per share

January 1 Outstanding 280,000
November 1 Conversion (30,000 × 3 × 2/12) 15,000
Average ordinary shares 295,000

Net income 4,000,000

Preference dividend (20% × 2,400,000 × 1) ( 480,000)
Net income to ordinary shares 3,520,000

Basic earnings per share 11.93

Diluted Earnings per share

January 1 Outstanding 280,000
November 1 Conversion 30,000
Total ordinary shares 310,000
Net income 4,000,000

Diluted Earnings per share (4,000,000 ÷ 310,000) 12.90

Observe that the issuance of ordinary shares on November 1 is not averaged anymore because it is
outstanding at the beginning of the year.

Problem 3

On January 1, 2020, Asiong company reported the following share capital balances:
 Ordinary share capital, P35 par, 250,000 shares
authorized, 180,000 shares issued and outstanding 6,300,000

During the same date, the entity issued 30,000 share options to employees allowing them to
purchase one ordinary share for 5 options at P125.

The fair value of each share option is P30.

The average market price is for the current year is P200.

The entity earned a total net income of P3,960,000.

Compute for the basic earnings per share and diluted earnings per share for the year.

Solution:

Basic Earnings per share

Net income 3,960,000
Divide by ordinary shares actually outstanding 180,000
Basic earnings per share 22

Diluted earnings per share

Net income 3,960,000
Option shares 30,000
Multiply by total option price 155
Proceeds from assumed exercise of options 4,650,000
Divide by average market price 200
Assumed treasury shares 23,250
To compute for the total option price:
Option price 125
Fair value of each stock option 30
Total option price 155

Ordinary shares actually outstanding 180,000

Incremental ordinary shares
Option shares 30,000
Assumed treasury shares ( 23,250) 6,750
Total ordinary shares 186,750

Diluted EPS (3,960,000 ÷ 186,750) 21.20

Problem 4

Using the given information below, compute for the basic earnings per share and diluted earnings
per share for the year.

Ordinary share capital, P50 par, 350,000 shares

authorized, 200,000 shares issued and outstanding 10,000,000
Net Income 4,200,000
50,000 share options issued on April 1. 50,000
Fair value of each share option 15
Exercise price 175
Average market price 200

Solution:

Basic Earnings per share

Net income 4,200,000
Divide by ordinary shares actually outstanding 200,000
Basic earnings per share 21

Diluted earnings per share

Net income 4,200,000
Option shares 50,000
Multiply by total option price 190
Proceeds from assumed exercise of options 9,500,000
Divide by average market price 200
Assumed treasury shares 47,500
To compute for the total option price:
Option price 175
Fair value of each stock option 15
Total option price 190

Ordinary shares actually outstanding 200,000

Incremental ordinary shares
Option shares 50,000
Assumed treasury shares ( 47,500) 2,500
Multiply by 9/12 (April 1) × 9/12
1,875

Total ordinary shares 201,875

 Diluted EPS (4,200,000 ÷ 201,875) 20.80

Problem 5

Paspasan Company reported the following information for the current year:

Ordinary share capital, P90 par, 40,000 shares issued 3,600,000

Preference share capital, P120 par, 10% cumulative
30,000 shares, each share is convertible
into 2 ordinary shares 3,600,000

Due to typhoon Nagloko, the entity’s operations substantially decreased by approximately 70%.
The entity wasn’t able to subdue losses, and there weren’t enough profit to offset it.

By the end of the year, the entity incurred a net loss of P4,000,000.

Determine the basic loss per share and diluted loss per share of the company for the current year.

Solution:

Basic loss per share

Net loss (4,000,000)
Preference dividend (10% × 3,600,000) ( 360,000)
Total loss to ordinary shareholders (4,360,000)
Divide by ordinary shares actually outstanding 40,000
Basic loss per share (109)

Diluted loss per share

Net loss (4,000,000)
Ordinary shares actually outstanding 40,000
Assumed ordinary shares issued through conversion
of preference shares 60,000
Total ordinary shares 100,000
Diluted loss per share (4,000,000 ÷ 100,000) (40)