Chapter 20 – Shareholder’s Equity

3 form of business organization:

 Single proprietorship – the owner’s claim against the assets is called capital or owner’s equity.
 Partnership – the partners’ claim against the assets is called partners’ capital or partners’ equity
 Corporation – the owner’s claim against the assets is called shareholders’ equity or stockholders’
equity

In a single proprietorship and partnership, the investment of the owner or owners and the changes
therein resulting from net income or loss from operations are recorded in the capital accounts.

In a corporation, distinction is made between invested capital and earnings or losses accumulated in the
business.

Concept of a corporation

A corporation is an artificial being created by operation of law, having the right of succession, and the
powers, attributes, and properties expressly authorized by law or incident to its existence. It is a legal or
judicial person with a personality separate and apart from the individual members or shareholders who,
as natural persons, are merged in one corporate body.

It is not in fact and in reality a person but the law treats it as though it were a person by process of
fiction.

Organization of a corporation

A corporation is created by operation of law. This means that it requires the authority and grant from
the state.

In the Philippines, the general law which governs the creation of private corporations is the Corporation
Code.

Private corporations owned or controlled by the government or any subdivision or instrumentality

thereof are created by special laws.

Legal requirement

The Corporations Code provides that:

 5 or more persons, not exceeding 15, a majority of whom are residents of the Philippines
 File with the SEC the articles of incorporation, duly executed and acknowledged before a notary
public

Contents of Articles of Incorporation

a. The name of the corporation

b. The purpose/s for which the corporation is formed
c. The place where the principal office the corporation is to be established or located, which place
must be within the Philippines
d. The term for which the corporation is to exist not exceeding 50 years.
 e. The names and residences of the incorporators
f. The names and addresses of the incorporating directors who must not be less than five nor
more than fifteen.
g. The amount of share capital, its par value, and the number of shares into which it is divided. If
the share has no par value, the articles need state only the number of shares but the fact that
the share is without par shall be stated therein.
h. The amount of share capital or the number of no par shares actually subscribed, including the
names and residences of the subscribers with an indication of the amount or number or no par
shares subscribed and paid by each.

The corporation commences from the moment the SEC issues a certificate of incorporation. The
issuance of it calls the corporation to being but it is not yet ready to do business until it is organized.

The corporation must formally organize and commence operations within 2 years from the date of its
incorporation.

Formal organization requires the adoption of by-laws and the election of officers by the board of
directors pursuant to the by-laws.

By-laws

It may be defined as the rules of action adopted by the corporation for its internal government and for
the government of its officers, shareholders, or members.

This shall be adopted and filed with the SEC within one month from the date of incorporation. Failure to
do so shall render the corporation liable for the revocation of its registration.

Contents of by-laws

a. The time, place, manner of calling and rules for meetings of shareholders and directors. The
place of shareholders’ meeting must be the principal place of business.
b. The number, qualifications, duties, powers, and length of office of directors. A director must be
a registered owner of at least one share of stock, and majority of the directors must be residents
of the Philippines.
c. The appointment, duties, powers, compensation and length of corporate officers other than
directors.
d. The manner of issuing share certificates
e. The method of amending by-laws
f. Any other rules governing the acts of officers and directors.

Preincorporation subscription requirement

The SEC shall not register any stock corporation unless 25% of its authorized number of shares has been
subscribed, and at least 25% of the subscription has been paid.

However, in no case, shall the paid in capital be less than P5,000.

Components of corporation

a. Corporators – those who compose the corporation whether shareholders or members or both.
 b. Incorporators – those corporators mention in the articles of incorporation as originally forming
and composing the corporation.
c. Shareholders or stockholders – owners of shares in a stock corporation
- May be natural or artificial persons but only natural persons can be incorporators.
d. Members – corporators of a nonstock corporation.

Books and records of a corporation

a. Minutes book – contains the minutes of the meetings of the directors and shareholders.
b. Stock and transfer book – record of the names of shareholders
c. Books of accounts – record of all business transactions
d. Subscription book – book of printed blank subscription
e. Shareholders’ ledger – subsidiary for the share capital issued
f. Subscribers’ ledger – subsidiary for the subscriptions receivable account
g. Share certificate book – book of printed blank share certificates

Organization cost

It represents cost incurred in forming or organizing a corporation.

It includes:

a. Legal feels in connection with the incorporation

b. Incorporation fees
c. Share issuance costs

Start-up costs which include legal and secretarial costs in establishing a legal entity shall be recognized
as expense.

Organization cost shall be expensed except share issuance costs.

Shareholders’ equity

It is the residual interest of owners in the net assets of the corporation measured by the excess of assets
over liabilities.

Elements:

Philippine term IAS term

Capital stock Share capital – total par or stated value of the shares issued

Subscribed share capital Subscribed share capital – portion of the authorized SC subscribed but
not yet fully paid therefore still unissued. It is reported minus subscriptions receivable not collectible
currently.

Common stock Ordinary share capital

Preferred stock Preference share capital

Additional paid in capital Share premium – portion of the paid in capital representing excess over
the par or stated value.
RE (deficit) Accumulated profits (losses) – cumulative balance of periodic earnings,
dividend distributions, prior period errors and other capital adjustments

RE appropriated Appropriation reserve

Revaluation surplus Revaluation reserve – excess of revalued amount over the CA of the
revalued asset.

Treasury stock Treasury share – corporation’s own shares that have been issued and
then reacquired but not canceled.

Common sources of premium:

a. Excess over par value or stated value

b. Resale of treasury share at more than cost
c. Donated capital
d. Issuance of share warrants
e. Distribution of share dividends
f. Quasi-reorganization and recapitalization

Capital Stock

It is the amount fixed in the articles of incorporation to be subscribed and paid in or secured to be paid
in by the shareholders.

The amount fixed in the AOI is called the authorized share capital. The share capital is divided into
shares evidenced by a share certificate.

4 rights of a shareholder are:

a. To share in the earnings of the corporation

b. To vote in the election of directors and in the determination of certain corporate policies
c. To subscribe for additional share issues
d. To share in the net assets upon liquidation

A share certificate is the instrument that evidences the ownership of a share. It is issued only when the
subscription is fully paid.

The SC may be par value share or no-par value share.

Par-value share – value fixed in the AOI and appearing on the share certificate.

No-par share –without any value appearing on the share certificate but has always an issued value or
stated value. The minimum consideration or issue price is P5.

Ordinary share capital

It is so called because the ordinary shareholders have the same rights and privileges. Ordinary
shareholders have no fixed or specific return on investment.
Preference share capital

The preferences granted to the shareholders usually pertain to claims on dividends and net assets upon
liquidation. Shareholders have only a limited or fixed return on investment.

Legal capital

It is the portion of the paid in capital which cannot be returned to the shareholders in any form during
the lifetime of the corporation.

The amount is determined as follows:

a. In the case of par value share, it is the aggregate par value of the shares issued and subscribed.
b. In the case of no-par value share, it is the total consideration received from shareholders
including excess over the stated value.

Trust fund doctrine

It holds that SC is a trust fund for the protection of creditors. It is illegal to return such to shareholders
during the lifetime of the corporation.

Accounting for share capital

a. Memorandum method – only a memo entry is made to record the authorized SC. When SC is
issued, it is credited to the share capital account.
b. Journal entry method – authorization is recorded by debiting unissued SC and crediting
authorized SC. When SC is issued, it is credited to the unissued SC.

Issuance of share capital

Shares with par value – credited to the SC account to the extent of the par value with any excess being
reflected as SP.

Shares without par value – credited to the SC account to the extent of the stated value with any excess
being reflected as SP.

Share issued at discount

When shares are sold at a price which is below par or stated value.

The discount is considered a liability for the shareholder called discount liability of the shareholder.

The account discount on share capital is a deduction from total shareholders’ equity.

Treasury shares may be sold or reissued for less than par or stated value.

Issuance of share capital for noncash consideration

The valuation shall be initially determined by the incorporators or the BOD subject to approval of the
SEC.

The SC is recorded at an amount equal to the following in order of priority:

a. FV of the noncash consideration received

 b. FV of the shares issued
c. Par value of the shares issued

Issuance of share capital for services

Shares may be issued for services as long as the services are already rendered. It shall be recorded at the
FV of such services or of the shares issued, whichever is reliably determinable.

Share issuance costs

These are direct costs to sell share capital which normal include legal fees, CPA fees, underwriting fees,
commissions, cost of printing certificates, documentary stamps, filing fees with SEC and cost of
advertising and promotion or newspaper publication fee.

This shall be deducted from equity, net of any related income tax benefit. In other words, this shall be
debited to share premium arising from share issuance. If insufficient to absorb such expenses, the excess
shall be debited to share issuance costs as a contra equity account as a deduction from the following in
the order of priority:

a. Share premium from previous share issuance

b. RE

Costs of public offering of shares

These are not incremental costs attributable to the issuance of new shares and shall be recorded as
expense in the income statement.

Costs of listing shares include:

a. Road show presentation

b. Public relations consultant’s fee

Joint costs

Transaction costs that relate jointly to the concurrent listing and issuance of new shares, and listing of
old existing shares shall be allocated between the newly issued and listed shares, and the newly listed
old existing shares.

The PIC concluded that the joint costs shall be allocated prorata on the basis of outstanding newly
issued and listed shares and outstanding newly listed old existing shares.

Examples:

a. Audit and other professional advice relating to prospectus

b. Opinion of counsel
c. Tax opinion
d. Fairness opinion and valuation report
e. Prospectus design and printing
The cost of PO is expensed immediately

Share listing fee

Cash

The share issuance costs shall be recorded as follows:

a. If the new shares are issued at more than par:

Share premium
Cash
b. If the new shares are issued at par
Share issuance costs
Cash

Allocation of joint costs

Share premium

Stock listing fee

Cash

Watered share

It is share capital issued for inadequate or insufficient consideration. The consideration received is less
than par or stated value but the SC is issued as fully paid. Asset and capital are overstated.

To correct the accounts, the journal entry is:

Discount on share capital

Land

Secret reserve

It is the reverse of watered share. It arises when the asset is understated or liability is overstated with a
consequent understatement of capital. It usually arises from the following:

a. Excessive provision for depreciation, depletion, amortization and doubtful accounts.

b. Excessive writedown of receivables, inventories and investments.
c. Capital expenditures are recorded as outright expense.
d. Fictitious liabilities are recorded.

Delinquent subscription

The official declaration of due and payable unpaid subscriptions by the BOD is called a call usually
expressed in the form of a board resolution stating the date fixed for payment of the unpaid
subscriptions.

If the shareholder doesn’t pay on the date fixed, the shareholder is declared delinquent and the
delinquent share will be sold at public auction to the highest bidder.
The highest bidder is the person who is willing to pay the offer price of the delinquent shares for the
smallest number of shares. The offer price includes:

a. Balance due on the subscription

b. Interest accrued on the subscription due
c. Advertising expenses and other costs of sale

No bidders

The corporation may purchase for itself the delinquent shares.

Journal entries

a. To record expenses incurred in connection with the auction of the DS

Advances on delinquency sale
Cash
b. Treasury shares

Subscription receivable

Interest income

Advances on delinquency sale

c. Subscribed share capital

Share capital

Callable preference share

It is one which can be called in for redemption at a specified price at the option of the corporation.

As distinguished from a redeemable preference share, a callable preference share has no definite
redemption date as this dependent on the “call” of the issuer.

It is an equity instrument.

When the preference shares are called in at more than the original issue price of the preference shares,
the excess is debited to RE.

Accordingly, the excess of the call price over the par value of the preference shares is charged to the
following:

a. Share premium from original issuance of the preference share

b. Retained earnings

On the other hand, when preference shares are called in at less than original issue price, the difference
is simply credited to share premium related to ordinary shares

Redeemable preference shares

a. A preference share that provides for mandatory redemption by the issuer for a fixed or
determinable amount at a future date.
 b. A preference share that gives the holder the right to require the issuer to redeem the
instrument for a fixed or determinable amount at a future date.

It shall be classified as current or noncurrent financial liability depending on the redemption date.

The difference between the redemption price and the financial liability is accounted for as gain or loss
on redemption.

Journal entry

To record issuance

Cash

Redeemable preference share

If a dividend is paid

Interest expense

Cash

Convertible preference share

It is one which gives the holder the right to exchange the holdings for other securities of the issuing
corporation.

A preference shareholder may convert the preference share into bonds which is actually a change of
equity from that of an owner to that of a creditor.

Normally, preference share is convertible into ordinary share.