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Module 2 Equity
Module 2 Equity
LEARNING OBJECTIVES:
1. Discuss the characteristics of the corporate form of organization.
2. Identify the key components of equity.
3. Explain the accounting procedures for issuing shares.
4. Describe the accounting for treasury shares.
5. Explain the accounting for and reporting of preference shares.
6. Describe the policies used in distributing dividends.
7. Identify the various forms of dividend distributions.
8. Explain the accounting for small and large share dividends, and for share splits.
9. Indicate how to present and analyze equity.
OVERVIEW
Shareholders’ Equity represents monetary contributions from a company’s stock (equity) owners and from
the course of its operations. Along with liabilities, Shareholders’ Equity forms another major source of
funding for companies. Companies can choose to fund themselves through the sale of their shares of
stock and through retained earnings, which they have accumulated over the course of their existence.
Shareholders’ equity
Shareholders’ equity is the residual interest in the assets of a corporation after deducting all its liabilities.
Preferred
Stock that has special rights and takes priority over common stock
Stock
Common
Stock Par Par value of units of ownership of a corporation
Value
Share
Represents capital received by a company when its shares are sold above their par
Premium
value
(APIC)
Treasury Common stock that had been issued and then reacquired (bought back) by a
Stock company
Retained Total amount of earnings of a company since its inception minus dividends and
Earnings losses (if any)
Share System
In the absence of restrictive provisions, each share carries the following rights:
1. To share proportionately in profits and losses.
2. To share proportionately in management (the right to vote for directors).
3. To share proportionately in assets upon liquidation.
4. To share proportionately in any new issues of shares of the same class—called the
preemptive right.
Issuance of Shares
Accounting problems:
1. Par value shares.
2. No-par shares.
3. Shares issued in combination with other securities.
4. Shares issued in non-cash transactions.
5. Costs of issuing shares.
Illustration:
An entity issues 5,000 shares with par value of 100 per share for 120 per share. The issuance is
recorded as follows:
Cash 600,000
Share capital 500,000
Share premium 100,000
Issued price (5,000 x 120) 600,000
Par value (5,000 x 100) 500,000
Share premium (5,000 x 20) 100,000
Note: The excess of issued price over the par value is share premium.
No-Par Shares
Reasons for issuance:
◆ Avoids contingent liability.
◆ Avoids confusion over recording par value versus fair market value.
No-par value shares is one without peso value fixed in the articles of incorporation. However, a no-par
value share has a stated value which is also indicated in the articles of incorporation but not on a share
certificate issued. Par value and no-par value share are distinguished by the presence or absence of a
value per share on the share certificate issued. Under the Corporation Code, no-par value shares should
not be issued for a consideration less than 5 pesos per share. Upon issuance the excess of issued price
over the stated value s credited to share premium.
Pro forma entry upon issuance:
Cash xx
Share capital xx
Share Premium xx
Illustration:
Ozz Corp. issues 1,000 5 par value ordinary shares and 1,000 20 par value preference shares for a lump
sum of 60,000. At the issue date, the ordinary shares were selling for 36 and the preference shares were
selling for 28.
The entry to record the issuance is as follows:
Cash 60,000
Preference Share 20,000
Ordinary Share 5,000
Share Premium – PS 6,250
Share Premium – OS 28,750
Illustration:
On December 1, 2020, Tris Corporation exchanged 20,000 shares of its 10 par value ordinary shares
held in treasury for a used machine. The treasury shares were acquired by Tris at a cost of 40 per share,
and are accounted for under the cost method. On the date of the exchange, the ordinary shares had a fair
value of 55 per share (the shares were originally issued at 30 per share).
Entry:
Machinery 1,100.000
TS 800,000
Shares issued for services or property other than cash should be recognized at:
1. fair value of the goods or services received.
2. If the fair value of the goods or services cannot be measured reliably, use the fair value of the
shares issued.
Since the fair value of property received is not determinable, priority 2 shall be used.
FV of shares (20,000 x 55) = 1,100,00; the difference between FV and cost of TS is share
premium
These expenditures, called share issuance cost, are deducted from any resulting share premium from the
issuance. If share premium is insufficient, the excess is charge to retained earnings.
Illustration:
On January 1, 20x1, XYZ Co. issued 1,000 shares with par value of 100 for 120 per share. Share
issuance cost amounted to 5,000.
The entries are as follows:
Cash (115 x 1,000) 115,000
Share Capital (1,000 x 100) 100,000
Share Premium ((120-5-100) x 1,000) 15,000
Reacquisition of Shares
Corporations purchase their outstanding shares to:
◆ Provide tax-efficient distributions of excess cash to shareholders.
◆ Increase earnings per share and return on equity.
◆ Provide shares for employee compensation contracts or to meet potential merger needs.
◆ To reduce the number of shareholders.
◆ Make a market in the shares.
Illustration:
On January 1, 20x1, the statement of financial position of XYZ Co. shows the following information:
Share capital (100 par) 800,000
Share premium 160,000
Retained earnings 540,000
Total shareholders’ equity 1,500,000
When treasury shares are subsequently reissued at below cost, the excess of cost over the reissuance
price is debited to the following order of priority:
a. Any balance in “share premium – treasury shares” arising from the same class of share capital.
b. If the balance in “share premium – treasury shares” is insufficient, any excess is debited to
retained earnings.
When shares are reacquired and immediately retired, the excess of cost over the original issued price
shall be charge to:
1. Share premium from treasury stock
2. Retained earnings
Preference Share
Features often associated with preference shares.
1. Preference as to dividends.
2. Preference as to assets in the event of liquidation.
3. Convertible into ordinary shares.
4. Callable at the option of the corporation.
5. Non-voting.
The accounting for preference shares at issuance is similar to that for ordinary shares.
Dividend Policy
Few companies pay dividends in amounts equal to their legally available retained earnings. Why?
◆ Maintain agreements with creditors.
◆ Meet state incorporation requirements.
◆ To finance growth or expansion.
◆ To smooth out dividend payments.
◆ To build up a cushion against possible losses.
Types of Dividends
1. Cash dividends.
2. Property dividends.
3. Liquidating dividends.
4. Share dividends.
All dividends, except for share dividends, reduce the total equity in the corporation.
Cash Dividends
◆ Board of directors vote on the declaration of cash dividends.
◆ A declared cash dividend is a liability.
◆ Companies do not declare or pay cash dividends on treasury shares.
Three dates:
a. Date of declaration
b. Date of record
c. Date of payment
Illustration: Roadway Freight Corp. on June 10 declared a cash dividend of 50 cents a share on 1.8
million shares payable July 16 to all shareholders of record June 24.
Property Dividends
◆ Dividends payable in assets other than cash.
◆ Restate at fair value the property it will distribute, recognizing any gain or loss.
If the property dividend is a noncurrent asset it shall be, subject to the requirements of PFRS 5 Non-
current Assets held for sale and discontinued Operation, reclassified as “Non-current asset held for
distribution to owners” and subsequently accounted for under PFRS 5.
Under PFRS 5, a “Non-current asset held for distribution to owner” is initially and subsequently measured
at the lower of its carrying amount and fair value less cost to distribute.
A loss is recognized if the fair value less cost to distribute is below to carrying amount. A subsequent
increase in fair value less cost to distribute is recognized as a gain but only to the extent of the
cummulative losses recognized in previous period. In no case shall the asset be measured in excess of
its original carrying amount. Gain in losses on measurement are recognized in profit or loss. Moreover
depreciation ceases during the period that the asset is classified as “Non-current asset held for
distribution to owner.
If the property dividend is a current asset, it shall be accounted for under its previous accounting. No
reclassification is needed.
Notes:
⮚ “Retained earnings” and “Property dividends payable” are recognized at fair value on declaration
date.
⮚ The investment in associate is reclassified to “non-current asset held for distribution to owners”
and measured at the lower of its carrying amount and fair value less cost to distribute.
⮚ The excess of the carrying amount over the fair value less distribution cost is recognized as
impairment loss (1,000,000 -800,000 = 200,000)
If the property dividend are not yet distributed to the owners as of December 31, 20x1. The pertinent
entries are as follows:
Dec.31, Retained earnings 300,000 300,000
20x1 Property dividends payable
To adjust dividends for the change in fair value.
Notes:
⮚ The fair value adjustment to the “property dividends payable” is recognized directly to retained
earnings.
⮚ The gain on impairment recovery is recognized only to the extent of previous impairment
Notes:
⮚ The property dividends payable is again adjusted to fair value on settlement date.
⮚ The difference between the carrying amount of property dividends payable and the asset
distributed is recognized in profit or loss.
Liquidating Dividends
Any dividend not based on earnings reduces amounts paid-in by shareholders.
Illustration: McChesney Mines Inc. issued a “dividend” to its ordinary shareholders of 1,200,000. The
cash dividend announcement noted that shareholders should consider 900,000 as income and the
remainder a return of capital. McChesney Mines records the dividend as follows.
Date of declaration
Retained Earnings 900,000
Share Premium—Ordinary 300,000
Dividends Payable 1,200,000
Share Dividends
◆ Issuance by a company of its own shares to shareholders on a pro rata basis, without
receiving any consideration.
◆ When share dividend is less than 20 percent of the ordinary shares outstanding,
company transfers fair market value from retained earnings (small share dividend).
Illustration: Vine Corporation has outstanding 1,000 shares of 100 par value ordinary shares and
retained earnings of 50,000. If Vine declares a 10 percent share dividend, it issues 100 additional
shares to current shareholders. If the fair value of the shares at the time of the share dividend is 130
per share, the entry is:
Date of declaration
Retained Earnings 13,000
Ordinary Share Dividend Distributable 10,000
Share Premium—Ordinary 3,000
Share Split
◆ To reduce the market value of shares.
◆ No entry recorded for a share split.
◆ Decrease par value and increased number of shares.
MODULE # 2 Post-test
PRACTICAL ACCOUNTING 1 – REVIEW
EQUITY
PROF. U.C. VALLADOLID
Multiple Choice
Identify the choice that best completes the statement or answers the question.
1 1. Effective December 31, 2020, the stockholders of Joshtin Company approved a two-for-one split of the
company’s ordinary share, and an increase in authorized ordinary share shares from 100,000 shares (par
value P20 per share) to 200,000 shares (par value P10). Joshtin’s stockholders’ equity accounts
immediately before issuance of the stock split shares were as follows:
Ordinary share, par value P20; 100,000 shares authorized; 50,000 shares
outstanding 1,000,000
Share premium 150,000
Retained earnings 1,350,000
What should be the balances in Joshtin’s share premium and retained earnings accounts immediately after
the stock split is effected?
Share premium Retained earnings
a. 0 500,000
b. 150,000 350,000
c. 150,000 1,350,000
d. 1,150,000 350,000
2. Of the 125,000 shares of ordinary share issued by Tina Company, 25,000 shares were held as treasury
stock at December 31, 2019. During 2020, transactions involving Tina’s ordinary share were as follows:
January 1 through October 31 – 13,000 treasury shares were distributed to officers as part of a stock
compensation plan.
November 1 – A 3 – for – 1 stock split took effect.
December 1 – Tina purchased 5,000 of its own shares to discourage an unfriendly takeover. These shares
were not retired.
At December 31, 2020, how many shares of Tina’s ordinary share were issued and outstanding?
Issued Outstanding
a 375,000 334,000
b 375,000 324,000
c 334,000 334,000
d 324,000 324,000
3. On July 1, 2020, Kristine Company issued rights to stockholders to subscribe to additional shares of its
ordinary share. One right was issued for each share owned. A stockholder could purchase one
additional share for 10 rights plus P30 cash. The rights expired on December 31, 2020. On July 1, 2020,
the market price of a share with the right attached was P40 while the market price of one right alone was
P2. All stock rights were exercised on December 31, 2020. Kristine’s stockholders’ equity on June 30,
2020 comprised the following:
Ordinary share, P25 par value, 40,000 shares issued and outstanding
1,000,000
Share premium 600,000
Retained earnings 800,000
4. On July 1, year 1, Jerome Corp. issued rights to stockholders to subscribe to additional shares of its
common stock. One right was issued for each share owned. A stockholder could purchase one additional
share for 10 rights plus 15 cash. The rights expired on September 30, year 1. On July 1, year 1, the
market price of a share with the right attached was 40, while the market price of one right alone was 2.
Jerome’s stockholders’ equity on June 30, year 1, comprised the following:
Common stock, 25 par value, 4,000 shares issued and outstanding 100,000 Additional paid-in capital
60,000 Retained earnings 80,000 By what amount should Jerome’s retained earnings decrease as a
result of issuance of the stock rights on July 1, year 1?
a. 0
b. 5,000
c. 8,000
d. 10,000
From what Jerome Company has reported, what is the legal capital?
a. 10,766,000
b. 16,173,000
c. 12,973,000
d. 13,966,000
6. At its date of incorporation, Joseph, Inc. issued 100,000 shares of its 10 par ordinary shares at 11 per
share. During the current year, Joseph acquired 20,000 ordinary shares at a price of 16 per share and
accounted for them by the cost method. Subsequently, these shares were reissued at a price of 12 per
share. There have been no other issuances or acquisitions of its own ordinary shares. What effect does the
reissuance of the shares have on the following accounts?
Retained Earnings Share Premium
a. Decrease Decrease
b. No effect Decrease
c. Decrease No effect
d. No effect No effect
7. Ozz Company issued 1,000,000 shares of P38 par value for P50 per share in year 2019. In 2020, the entity
reacquired 200,000 shares at P67 per share. Immediately, all of these reacquired shares were retired.
What amount should be debited to share premium and retained earnings, respectively in connection of the
retirement of the shares?
a. 11,000,000 2,400,000
b. 5,800,000 2,400,000
c. 3,400,000 2,400,000
d. 13,400,000 2,400,000
8. Ozz Corp. issues 1,000 5 par value ordinary shares and 1,000 20 par value preference shares for a lump
sum of 60,000. At the issue date, the ordinary shares were selling for 36 and the preference shares were
selling for 28. The Share Premium—Ordinary account will be credited for
a. 31,000
b. 36,000
c. 26,250
d. 28,750
9. Tris Corporation was organized on January 1, 2020, with an authorization of 1,200,000 ordinary shares
with a par value of 6 per share. During 2020, the corporation had the following capital transactions:
January 5 issued 675,000 shares @ 10 per share
July 28 purchased 90,000 shares @ 11 per share
December 31 sold the 90,000 shares held in treasury @ 18 per share
Tris used the cost method to record the purchase and reissuance of the treasury shares. What is the total
amount of share premium as of December 31, 2020?
a. -0-.
b. 2,070,000.
c. 2,700,000.
d. 3,330,000.
10. On December 1, 2020, Tris Corporation exchanged 20,000 shares of its 10 par value ordinary shares held
in treasury for a used machine. The treasury shares were acquired by Tris at a cost of 40 per share, and
are accounted for under the cost method. On the date of the exchange, the ordinary shares had a fair value
of 55 per share (the shares were originally issued at 30 per share). As a result of this exchange, Tris's total
equity will increase by
a. 200,000.
b. 800,000.
c. 1,100,000.
d. 900,000.
11. Angel Co. issues 10,000 shares of 10 par value convertible preference shares for 12 cash per share.
Each share is convertible into 4 ordinary shares. On this date the 1 par value ordinary shares are selling
for 3 per share. Approximately 2 years later, Angel’s shareholders convert their preference shares into
ordinary shares. On the date of conversion the preference shares are selling for 16 and the ordinary
shares are selling for 5 per share. The journal entry on the date of issuance will include which of the
following?
a. Credit Share Capital—Preference 20,000.
b. Credit Share Premium—Ordinary 20,000.
c. Credit Share Capital—Preference 100,000.
d. Debit Share Premium—Ordinary 20,000.
12. In 2020, Ozz, Inc., issued for 103 per share, 60,000 shares of 100 par value convertible preference shares.
One share of preference shares can be converted into three shares of Ozz's 25 par value ordinary shares
at the option of the preference shareholder. In August 2021, all of the preference shares were converted.
The fair value of the ordinary shares at the date of the conversion was 30 per share. What total amount
should be credited to share premium—ordinary as a result of the conversion of the preference shares into
ordinary shares?
a. 1,020,000.
b. 780,000.
c. 1,500,000.
d. 1,680,000.
13. On March 1, 2020, Tris Corporation issued 800,000 of 8% nonconvertible bonds at 104, which are due on
February 28, 2032. In addition, each 1,000 bond was issued with 25 detachable share warrants, each of
which entitled the bondholder to purchase for 50 one share of Tris ordinary shares, par value 25. The bonds
without the warrants would normally sell at 95. On March 1, 2020, the fair value of Tris’s ordinary shares
was 40 per share and the fair value of the warrants was 2. What amount should Tris record on March 1,
2020 as share premium—share warrants?
a. 40,000
b. 41,600
c. 72,000
d. 83,200
14. During year 1, Kaila Co. issued 5,000 shares of 100 par convertible preferred stock for 110 per share.
One share of preferred stock can be converted into three shares of Kaila’s 25 par common stock at the
option of the preferred shareholder. On December 31, year 3, when the market value of the common
stock was 40 per share, all of the preferred stock was converted. What amount should Kaila credit to
Common Stock and to Additional Paid-in Capital—Common Stock as a result of the conversion?
15. In 2019, Kyutsi-a Co. acquired 10,000 shares of its P1 par value common stock at P6 per share. During
2020, Kyutsi-a Co. issued 3,000 of these shares at P50 per share. Kyutsi-a Co. uses the cost method to
account for its treasury stock transactions. What is the balance of the treasury stock from the issuance of
the 3,000 shares?
a.P108,000
b.P42,000
c.P6,000
d.P102,000