Chapter 19: Audit of Owners’ Equity

Review Questions

1. What audit procedures may be employed to establish the (a) existence or occurrence
and (b) rights and obligations of shareholders’ equity balances?
(a) Procedures applicable to the existence or occurrence of shareholders’ equity
balances are:
(1) Obtain schedules of shareholders’ equity accounts and reconcile to the general ledger
balances,
(2) review authorizations and terms of share issues,
(3) confirm shares outstanding with registrar on share and transfer agent,
(4) inspect share certificate book, and
(5) inspect certificates of shares held in treasury.
(b) Procedures applicable to rights and obligations are:
(1) make inquiries of legal counsel, and
(2) review articles of incorporation and by-laws.

2. List the procedures that are required in vouching dividend payments.

In vouching dividend entries, the auditor should:
(a) establish that preferential or other rights of shareholders and any restrictions on dividend
distributions have been recognized,
(b) establish the number of shares outstanding on the date of record and verify the accuracy
of the total dividend declaration by recalculation,
(c) ascertain the propriety of the entry to record the declaration, and
(d) trace dividend payments to canceled checks and other documentation.

3. What procedures are used in determining whether there is proper statement

presentation and disclosure of shareholders’ equity items?
The procedures consist of:
(a) review minutes of board of directors’ and shareholders’ meetings for share options and
dividends restrictions, and
(b) Evaluate financial statement presentation and disclosure for shareholders’ equity accounts.

Exercises

Exercise 1
The Earla Company was incorporated July 10, 20X7, with an authorized capital as follows:
1. Ordinary shares, Class A, 20,000 shares, par value P25 per share
2. Ordinary shares, Class B, 100,000 shares, par value PS per share
The share capital account in the general ledger is credited with only one item in the year
20X7. This represents share capital sold for cash, at par, as follows:
1. Class A, 12,000 shares
2. Class B, 60,000 shares
The sum of open certificate stubs in the share certificate books at December 31, 20X7
indicates that 82,000 shares were outstanding.
Required:
a. State possible explanations for this apparent discrepancy.
 b. State the procedures you would perform to determine the cause of the discrepancy.

Answer:
a.
1) Certificates may have been surrendered in exchange for others without attaching the
surrendered certificates to the stub book.
2) The excess certificates may have been issued under proper authority for services or
for property and not recorded in the financial books.
3) They may have been issued improperly in exchange for cash, services or property, or
without consideration. The impropriety might result from oversight or from fraudulent
design.
4) The error may have occurred because an item which should have been posted to the
share capital account was not in fact so posted.
5) An error may have occurred in entering the number of shares issued on the certificate
stub.
b.
1) Make a quick inspection of open stubs to determine whether they provide a ready clue
to the reason for difference, e.g., one certificate issued for 10,000 shares. If so,
investigate the facts regarding its issue.
2) If a quick inspection fails to provide a clue, refer to a list of shareholders supporting
the entries in the cash receipts book for the 72,000 shares originally sold. Check this
list item by item against stubs for shares originally issued and mark the stubs so
checked. Then check returned certificates attached to stubs against new stubs issued in
exchange for those certificates, marking the new stubs. Prepare a list of unmarked
stubs. This should total 10,000 shares and serve to identify the outstanding certificates
with respect to which shares are not recorded in the general ledger.
3) If errors are found in the number of shares issued, as shown by stubs in the share
certificate book after comparison with the cash receipts entries, it may be necessary to
circularize the original shareholders to determine how many shares were actually
issued.
4) If it is found that excess shares have been issued, inquiry should be made of
responsible officers with respect to the circumstances in which they were issued. The
answers obtained should be substantiated by appropriate evidence, e.g., resolutions of
the board, etc.

Exercise 2
You are engaged in doing the audit of a corporation whose records have not previously
been audited by you. The corporation has both an independent transfer agent and a registrar
checks that there is no over issue of shares. Signatures of both are required to validate
certificates.
It has been proposed that confirmations be obtained from both the transfer agent and the
registrar as to the shares outstanding at statement of financial position. If such confirmations
agree with the books, no additional work is to be performed as to share capital.
Required:
If you agree that obtaining the confirmations as suggested would be sufficient in this
case, give the justification for your position. If you do not agree, state specifically all additional
steps you would take and explain your reason for taking them.

Answer:
 The proposal for the limitation of procedure is not justified by the stated facts. Although the
transfer agent and the registrar know the number of shares issued, they do not necessarily know the
number of shares outstanding. Furthermore, the audit of share capital includes more than determining
the number of shares outstanding. For example, the auditor must determine what authorizations exist
for the issuance of shares, what assets were received in payment of shares, how the transactions were
recorded, and what subscription contracts have been entered into. Confirmation from the registrar
could not help in determining these things. In addition to confirmation from the registrar, the audit of
share capital might include the following procedures for which the purposes are briefly indicated:
(1) Examine the corporation charter to determine the number of shares authorized and the
special provisions relating to each class of shares if more than one class is authorized.
(2) Examine minutes of shareholders’ and directors’ meetings to determine authorization for
appointments of the registrar and the transfer agent, and to determine authorization for the issuance
or reacquisition of shares.
(3) Examine provisions relating to share capital in the corporation law of the state of
incorporation to determine any special provisions such as, for example, those relating to the issuance
of no-par shares.
(4) Analyze the share capital accounts to obtain an orderly picture of share transactions for
use as a guide to other auditing procedures and as a permanent record.
(5) Trace the consideration received for share capital into the records to determine what
consideration has been received and how it has been recorded.
(6) Examine and schedule treasury shares and review entries for treasury shares to determine
the existence of treasury shares, as authorized, and to determine that a proper record has been made.
(7) Review registrar’s invoices and cash disbursements to determine that original issue taxes
have been paid.
(8) Compare dividends with shares outstanding at dividend dates to determine that dividends
have been properly paid and also to substantiate the shares outstanding.
(9) Review subscription and option contracts, etc., to determine the facts in regard to
subscriptions and options and to determine that these facts have been properly recorded and that they
are adequately disclosed.

Exercise 3: Correction of Errors: Statement of Financial Position Preparation

Talisay Corporation presented the following statement of financial position for
December 31, 20X7:
Assets
Current Assets P30,000
Treasury shares (at market; cost = P15,000) 14,000
Fixed Assets 56,000
Total Assets P100,000
Liabilities and Shareholders’ Equity
Current Liabilities P20,000
Ordinary Shares subscribed (500 shares) 10,000
Long-Term Debt 8,000
Total Liabilities 38,000
Shareholders’ Equity
Ordinary Shares (4,000 shares issued) 18,000
10% Preference Shares (1,000 shares issued) 12,000
Less: Share subscriptions receivable (4,000)
Reserve for depreciation 16,000
Earned surplus 20,000
Total liabilities and shareholders’ equity P100,000
 Your investigation of Talisay Corporation’s financial records indicates that all
authorized shares have been either issued or subscribed. In addition, the par values for the
ordinary and preference shares are P2 and P10, respectively. The treasury share was originally
purchased when the market price was P20 per share. During 20X7, 250 treasury shares were
resold for P25 per shares. A “gain on treasury share transactions” was credited for the
difference between the original cost and the selling price. Furthermore, the excess of cost over
market of the treasury shares at the end of the period was recognized as an unrealized loss on
the 20X7 income statement. You also discovered that the City of Makati donated land with a
market value of P9,000 to Talisay during 20X7. Share subscriptions receivable are due six
months from December 31, 20X7.
Required:
Revise the December 31, 20X7, statement of financial position for Talisay Corporation
as it should be presented according to financial reporting standards.

Answer:
Based on the limited data made available in the problem, the Balance Sheet is presented as
follows:
Talisay Corporation
Statement of Financial Position
December 31, 20X7
Assets
Current assets (including share subscriptions receivable) (30,000 + 4,000) P 34,000
Noncurrent assets
Land (From City of Manila; at market value) 9,000
Other fixed assets (net of accumulated depreciation of P16,000)
(16,000 from reserve for depreciation; 56,000 – 16,000) 40,000
Total assets P 83,000
Liabilities and Stockholders’ Equity
Current liabilities P 20,000
Long-term liabilities 8,000
Total liabilities P 28,000
Stockholders’ equity
10% Preference shares (P10 par value; 1,000 shares authorized,
issued, and outstanding) P 10,000
Ordinary shares (P2 par value; 4,500 shares authorized [ordinary
shares + shares subscribed], 4,000 shares issued, and 3,250 outstanding) 8,000
Ordinary shares subscribed (500 shares) 1,000 a
Share Premium (preference) 2,000
Share Premium (ordinary) 20,250 b
Donated capital 9,000
Retained earnings 19,750 c
Less: Treasury shares (750 shares at cost) (15,000) d
Total liabilities and shareholders’ equity P 83,000
a. 500 shares x P2 par value = P1,000
b. Amount on issued ordinary shares [P18,000 - (4,000 x P2)] P10,000
Amount on subscribed ordinary shares [P10,000 - (500 x P2)] 9,000
P19,000
Sale of treasury shares (250 x P25) P 6,250
Cost of treasury shares sold (250 x P20) ( 5,000) 1,250
P20,250
 c. P20,000 - P1,250 (improper gain) + P1,000 (improper loss) P19,750
d. P15,000 total cost  P20 cost per share = 750 shares

Exercise 4: Preparation of Shareholders’ Equity Section

Hope, Inc., a manufacturer of restaurant and kitchen equipment, was incorporated in
20X3. Its share is publicly held. The shareholders’ equity section of the statement of financial
position at September 30, 20X7, follows:
P2 Cumulative redeemable preference shares (P15 par value;
500,000 shares authorized, 4,000 shares issued and outstanding) P60,000
Ordinary shares (P10 par value; 1,000,000 shares authorized,
110,000 shares issued and outstanding) 1,100,000
Retained Earnings 622,000
Total shareholders’ equity P1,782,000
Hope’s share capital transactions during fiscal 20X8 were as follows:
1. On January 2, 8,000 preference shares were issued in exchange for land with an
appraised value of P100,000. Six months ago, 1,000 shares of Hope preference were
exchanged “over the counter” for P14 per share. (Preference Shares)
2. On January 17, 4,500 ordinary shares were sold to Torn Santos at P25 per share.
(Ordinary Shares)
3. On September 14, Hope purchased dissident shareholder Santos’ 4,500 shares at P27
per share. The shares are to be held at treasury shares and accounted for at cost.
(Santos violently opposed Hope’s business strategy and Hope’s management decided to
eliminate his interest.) (Treasury Shares)
4. On September 28, Hope contracted with Kathryn Reyes for the sale of 10,000 previously
unissued shares at P25 per share to be issued when the purchase price is fully paid. At
September 30, only P195,000 had been paid. Reyes agreed to pay the balance on or
before November 3, 20X8. (Ordinary Shares Subscribed, at par)
5. On September 30, Hope redeemed 4,000 preference shares according to the issue
agreement. The shares were redeemed at P18 per share. (Preference Shares)
6. A cash dividend of P2 was declared on the preference shares on March 11, and paid on
March 30.
7. A cash dividend of P1.50 per share was declared on September 15, and payable October
11.
8. Hope’s net income for fiscal year 2018 was P250,000.
Required:
Prepare the shareholders’ equity section of the statement of financial position for the
year ended September 30, 20X8. This statement should be supported by the following
schedules, presented in the order given:
a. Changes in preference shares account.
b. Changes in ordinary shares account.
c. Calculation of paid-in capital in excess of par.
d. Changes in retained earnings.

Answer:
Hope, Inc.
Shareholders’ Equity
As of September 30, 2007
P2 Cumulative redeemable preference shares (P15 par value;
500,000 shares authorized; 8,000 shares issued and
outstanding) P 120,000
Ordinary shares (P10 par value; 1,000,000 shares authorized,
114,500 shares issued, 110,000 shares outstanding) 1,145,000
Ordinary shares subscribed, 10,000 shares 100,000
Paid-in capital in excess of par (ordinary) 217,500
Discount on preference shares (20,000)
Retained earnings 671,000
Treasury shares (4,500 shares at cost) (121,500)
P2,112,000
(a)
Preference Shares Schedule
# of Shares Amount
Balance 9/30/06 4,000 P 60,000
Shares issued to purchase land 8,000 120,000
Shares redeemed (4,000) (60,000)
Balance 9/30/07 8,000 P120,000

(b)
Ordinary Shares Schedule
# of Shares Amount
Balance 9/30/06 110,000 P1,100,000
T. Santos 4,500 45,000
Balance 9/30/07 114,500 P1,145,000

(c)
Paid-in Capital Schedule
Amount
Balance 9/30/06 -0-
Sale to T. Santos [4,500 x (P25 - P10)] P 67,500
Subscription by K. Reyes [10,000 x (25 - P10)] 150,000
P217,500

(d)
Retained Earnings Schedule
Amount
Balance 9/30/06 P622,000
Net income 250,000
Preference shares redemption [4,000 x (P18 - P15)] (12,000)
Cash dividend – ordinary (110,000 x P1.50) (165,000)
Cash dividend – preference (12,000 x P2) (24,000)
P671,000

Exercise 5: Preparation of Statement of Financial Position After Quasi-Reorganization

Adverse financial and operating circumstances warrant that Baguio Company undergo
a quasi-reorganization at December 31, 20X8. The following information may be relevant in
accounting for the quasi reorganization.
1. Inventory with a cost of P215,000 is currently recorded in the accounts at its market
value of P200,000.
2. Plant assets with a fair market value of P700,000 are currently recorded at P875,000 net
of accumulated depreciation.
 3. A creditor agrees to extend the maturity date of a loan for five years, although interest
as originally stated must continue to be paid.
4. Individual shareholders contribute P600,000 to create additional paid-in capital to
facilitate the reorganization. No new shares are issued, although control of a majority of
the company’s outstanding shares passes to the company’s creditors.
5. The par value of the ordinary share is reduced from P25 to P15.
6. Immediately before the events described above, the shareholders’ equity section appears
as follows:
Ordinary shares (P25 par value; 100,000 shares
authorized and outstanding) P2,500,000
Paid-in capital in excess of par 1,750,000
Retained earnings (deficit) (750,000)
Total shareholders’ equity P3,300,000
Required:
Prepare the shareholders’ equity section of Baguio Company’s statement of financial
position after the quasi-reorganization.

Answer:
Baguio Company
Shareholders’ Equity
December 31, 2007

Ordinary shares (15 par value; 100,000 shares authorized,

and outstanding) P1,500,000
Paid-in capital in excess of par 2,425,000 *
Retained earnings (from Dec. 31, 2007) -0-___
Total Shareholders’ Equity P3,925,000

* Original balance P1,750,000

Reduction of par value of ordinary shares (P10 x 100,000) 1,000,000
Additional contribution 600,000
Elimination of deficit (925,000)**
Paid-in capital in excess of par P2,425,000
** Original deficit P750,000
Loss on revaluation of plant assets 175,000
Deficit to be eliminated P925,000

Exercise 6: Determination of Correct Retained Earnings Balance

The Retained Earnings account of Paranaque Company follows:
Date Item Dr. Cr.
7-01-2017 Balance P48,500
3-31-2017 Dividends paid P20,000
12-31-2017 Net income for the year 32,400
4-01-2018 Premium on share capital 15,000
6-30-2018 Gain on sale of treasury shares 10,000
9-30-2018 Dividends declared 30,000
12-31-2018 Net income for the year 45,100
Appraisal increase of land 30,000
Balance 131,000
P181,00 P181,10
 0 0
The corrected balance of Retained Earnings as at December 31, 20X8 should be:
a. P76,000 b. P106,000 c. P131,000 d. None of these

Answer:
Retained Earnings before adjustments P 131,000
Add (Deduct) Adjustments:
(a) Premium on share capital credited to retained earnings (P 15,000)
(b) Gain on sale of treasury shares incorrectly charged (10,000)
(c) Appraisal increase of land incorrectly credited to Retained Earnings (30,000)
Total adjustments P(55,000)
Retained Earnings after adjustments P 76,000

Exercise 7
The A4 Corporation has been operating successfully for several years. It is authorized to
issue 24,000 shares of no-par ordinary share and 6,000 shares of 8% P100 par preference
share. The Contributed Capital section of its January 1, 20X7 statement of financial position is
as follows:
8% preference shares, P100 par P210,000
Ordinary shares, no par 207,000
Premium on preference shares 18,900
P435,900
Part a. A shareholder has raised the following questions:
1. What is the legal capital of the corporation?
2. At what average price per share has the preference share been issued?
3. How many ordinary shares have been issued (the ordinary share has been issued at an
average price of P23 per share)?
Part b. The company engaged in the following transactions in 20X7:
March 2 Received a subscription to 400 shares of the 8% preference share. The total
subscription price is P122 per share and the contract requires a P10 per share
down payment. The remaining balance must be paid within 60 days or the share
subscription is defaulted. In the case of default, 20% of the down payment on the
defaulted shares is forfeited, and the remainder is returned to the defaulting
subscribers.
April 3 Sold 900 ordinary shares for P33 per share.
April 13 Issued 400 ordinary shares in exchange for land. The share is currently selling at
P34 per share.
May 1 Received remaining subscription balance (from March 2) owed on 350
preference shares and issued the shares.
May 4 Returned 80% of their down payment to defaulting subscribers and canceled the
related account balances.
June 1 Reacquired 500 ordinary shares at P37 per share. The company uses the cost
method to account for treasury shares.
October 19 Issued for P27,000 a combination of 500 ordinary shares and 100 preference
share. The ordinary and preference shares are currently selling for P35 and P125
per share, respectively.
November 16 Reissued the 500 treasury shares at P39 per share.
December 31 Distributed an P8 per share dividend on all preference shares outstanding and a
P2 per share dividend on all ordinary shares outstanding on this date (debit
Retained Earnings and credit Cash for each dividend).
Required:
Prepare the contributed capital section of the December 31, 20X7 statement of financial
position.

Answer:
Requirement (1) Part a
1. The legal capital is P417,000 (P210,000 + P207,000).
2. The average issuance price of the preference share is P109 per share [(P210,000 + P18,900)
 2,100 shares].
3. The number of ordinary shares issued is 9,000 shares (P207,000  P23).
Requirement (2) Part b
A4 Corporation
Contributed Capital Section of the Balance Sheet
December 31, 2006

Contributed Capital
8% Preference shares, P100 par (6,000 shares authorized,
2,550 shares issued and outstanding) P255,000
Ordinary shares, no par 24,000 shares authorized,
10,800 shares issued and outstanding) 266,050 *
Premium on preference shares 27,850 
Additional paid-in capital from share subscription default 100
Additional paid-in capital from treasury shares 1,000
Total contributed capital P550,000

* P207,000 + P29,700 + P13,600 + P15,750 = P266,050

 P18,900 + P8,800 – P1,100 + P1,250 = P27,850

The above schedule is supported by the following entries for the transactions that occurred in
2006:
2006
March 2 Cash (P10 x 400) 4,000
Subscriptions Receivable (P112 x 400) 44,800
Preference Shares Subscribed (P100 x 400) 40,000
Premium on Preference Shares 8,800
April 3 Cash (P33 x 900) 29,700
Ordinary Shares, no par (900 shares) 29,700
April 13 Land (P34 x 400) 13,600
Ordinary Shares, no par (400 shares) 13,600
May 1 Cash (P112 x 350) 39,200
Preference Shares Subscribed (P100 x 350) 35,000
Subscriptions Receivable 39,200
Preference Shares, P100 par 35,000
May 4 Preference Shares Subscribed (50 x P100) 5,000
Premium on Preference Shares (50 x P22) 1,100
Subscriptions Receivable (50 x P112) 5,600
Cash (50 x 0.8 x P10) 400
Additional Paid-in Capital from Share Subscriptions Default 100
June 1 Treasury Shares – Ordinary 18,500
Cash (500 x P37) 18,500
October 19 Cash 27,000
Ordinary Shares, no par (500 shares) 15,750*
Preference Shares, P100 par 10,000
Premium on Preference Shares 1,250
* Ordinary shares: P27,000 x (500 x 35 / [(500 x 35) + (100 x 125)]) = P15,750
Preference shares: P27,000 x (100 x 125) / [(500 x 35) + (100 x 125)]= P11,250
P27,000
November 16 Cash (P39 x 500) 19,500
Treasury Shares 18,500
Additional Paid-in Capital from Treasury Shares 1,000
December 31 Retained Earnings 21,600*
Cash 21,600
* Ordinary dividends: (9,000 + 900 + 400 + 500) x P2 = P21,600
December 31 Retained Earnings 20,400*
Cash 20,400
* Preferred dividends: (2,100 + 350 + 100) x (0.08 x P100) = P20,400

Exercise 8
Partner Corporation’s post-closing trial balance at December 31, 20X7 was as follows:
Debit Credit
Accounts Payable (L) P290,000
Accounts Receivable (A) P550,000
Accumulated depreciation – building and equipment (A) 200,000
Additional paid-in capital – ordinary shares (SHE)
In excess of par value 1,560,000
From sale of treasury shares 250,000
Allowance for doubtful accounts (A) 30,000
Bonds Payable (L) 400,000
Building and Equipment (A) 1,100,000
Cash (A) 220,000
Ordinary share capital (P1 par value) (SHE) 150,000
Dividends payable on preference shares – cash (L) 4,000
Inventories (A) 620,000
Land (A) 380,000
Investment in equity securities (at market ) @ FVOCI (A) 285,000
Trading equity securities (at market) (A) 215,000
Preference shares (P50 par value) (SHE) 500,000
Prepaid Expenses (A) 40,000
Retained Earnings (SHE) 231,000
Treasury Shares – ordinary (at cost) (SHE) 180,000
Unrealized decrease in value of investment in securities – OCI 25,000
(SHE)
Totals P3,615,00 P3,615,00
0 0
At December 31, 20X7 Partner had the following number of ordinary and preference
shares:
Ordinary Preference
Authorized 500,000 50,000
Issued 150,000 10,000
 Outstanding 140,000 10,000
The dividends on preference shares are P4 cumulative. In addition, the preference share
has a preference in liquidation of P50 per share.
Required:
Prepare the shareholders’ equity section of Partner’s statement of financial position at
December 31, 20X7.

Answer:
Partner Corporation
Shareholders’ Equity
December 31, 2006
Share capital
Preference shares, P4 cumulative, par value P50 per share;
authorized 50,000 shares, issued and outstanding
10,000 shares P 500,000
Ordinary shares, par value P1 per share; authorized 500,000
shares, issued 150,000 shares, and outstanding
140,000 shares 150,000
Total share capital P 650,000
Additional paid-in capital – ordinary
In excess of par value 1,560,000
From sale of treasury shares 250,000
Total paid-in capital P2,460,000
Retained earnings 231,000
Accumulated other comprehensive income (loss)
Unrealized decrease in value of available for sale securities (25,000)
Total paid-in capital, retained earnings, and accumulated other
comprehensive income (loss) P2,666,000
Less: Treasury shares, 10,000 shares at cost (180,000)
Total shareholders’ equity P2,486,000

Problems

Problem 1
On January 1, 20X7, Del-V Company had a retained earnings balance of P206,000.
During 2017, the following events occurred:
1. Treasury shares (ordinary) was acquired at a cost of P14,000. The law requires a
restriction in retained earnings in an equal amount. The company reports its retained
earnings restrictions in a note to the financial statements.
2. Cash dividends totaling P9,000 and share dividends totaling P6,000 were declared and
distributed.
3. Net income was P58,000.
4. Two thousand shares of callable preference shares were recalled and retired at a price of
P150 per share. This share has originally been issued at P130 per share.
5. A material error in net income for a previous period was corrected. This error
correction decreased retained earnings by P12,600 after a related income tax credit of
P5,400.
Required:
1. Prepare a statement of retained earnings for the year ended December 31, 20X7.
2. Prepare a note to disclose the restriction of retained earnings.
Answer:
Requirement (1)
Del-V Company
Statement of Retained Earnings
For Year Ended December 31, 2006

Retained earnings, as previously reported, January 1, 2006 P206,000

Less: Correction of overstatement of previous
net income (net of P5,400 income tax credit) (12,600)
Adjusted retained earnings, January 1, 2006 P193,400
Add: Net income 58,000
P251,400
Less: Cash dividends P 9,000
Share dividends 6,000
Reduction due to retirement of preference shares 40,000 (55,000)
Retained earnings, December 31, 2006 (See Note A) P196,400

Requirement (2)
Note A: Retained earnings are restricted in the amount of P14,000, the cost of the ordinary
shares being held as treasury shares.

Problem 2
RICY Corporation has experienced a net loss for a number of years. On the advice of
the board of directors, a new management team was appointed. Furthermore, the corporation
has agreed to a quasi-reorganization and to the revaluation of certain statement of financial
position account balances, subject to shareholder approval. The RICY statement of financial
position on December 31, 20X7 contained the following information prior to the
reorganization:
Current Assets P20,000 Liabilities P30,000
Property and equipment 110,000 Ordinary shares, P10 par 100,000
Less: Accumulated Additional paid-in capital
Depreciation (30,000) on ordinary shares 40,000
Retained Earnings (deficit) (70,000)
Total Assets P100,000 Total Liabilities and Shareholders’ Equity P100,000
The following information is relevant to the quasi-reorganization as approved by the
shareholders:
1. Property and equipment is determined to have a fair value of P45,000.
2. Current assets contain inventories overstated by P6,000.
3. Current assets contain uncollectible accounts receivable of P3,000.
4. Par value of ordinary shares is to be reduced to P1 per share as approved by the state of
incorporation.
Required:
1. Prepare journal entries to record the quasi-reorganization.
2. Prepare the statement of financial position of RICY Corporation immediately following
the quasi-reorganization. Include a note to accompany retained earnings.

Answer:
Requirement (1)
a. Write-down of property and equipment
 Retained Earnings (P80,000 – P45,000) 35,000
Accumulated Depreciation 35,000
b. Write-down of inventories
Retained Earnings 6,000
Current Assets (inventories) 6,000
c. Write-down of accounts receivable
Retained Earnings 3,000
Current Assets (accounts receivable) 3,000
d. Change in par value of ordinary shares
Ordinary Shares, P10 par 100,000
Ordinary Shares, P1 par 10,000
Additional Paid-in Capital on Ordinary Shares 90,000
e. Elimination of retained earnings deficit
Additional Paid-in Capital on Ordinary Shares 114,000
Retained Earnings * 114,000
* P114,000 = P70,000 deficit + P35,000 + P6,000 + P3,000

Requirement (2)
RICY Corporation
Balance Sheet
December 31, 2006

Current assets P 11,000

Property and equipment 110,000
Less: Accumulated depreciation (65,000)
Total assets P 56,000

Liabilities P 30,000
Ordinary shares, P1 par 10,000
Additional paid-in capital on ordinary shares 16,000
Retained earnings (see Note A) 0___
Total liabilities and shareholders’ equity P 56,000

Notes to Financial Statements

Note A: Retained earnings as of December 31, 2006 has a zero balance due to a quasi-
reorganization on that date. At that time, net assets were revalued, the par value of ordinary share
was reduced from P10 to P1 per share, and a P114,000 deficit was charged against additional paid-in
capital.

Problem 3
JTC Company has P80,000 available to pay dividends. It has 2,000 shares of 10% P100
par, preference shares and 30,000 shares of P10 par ordinary share outstanding. The
preference shares is selling for P125 per share and the ordinary share is selling for P20 per
share.
Required:
1. Determine the amount of dividends to be paid to each class of shareholder for each of
the following independent assumptions:
a. Preference share is non-participating and non-cumulative.
b. Preference share is non-participating and cumulative. Preference dividends are
two years in arrears at the beginning of the year.
 c. Preference share is fully participating and cumulative. Preference dividends are
one year in arrears at the beginning of the year.
d. Preference share is participating up to a maximum of 15% of its par value and is
non-cumulative.
2. For 1(a), compute the dividend yield on the preference share and the ordinary share.

Answer:
Requirement (1)
Preference Ordinary
a. Preferred dividend (2,000 x 0.10 x P100) P20,000
Remainder to ordinary (P80,000 – P20,000) P60,000
Total P20,000 P60,000

b. Dividends in arrears (2 x 2,000 x 0.10 x P100) P40,000

Current preferred dividend (2,000 x 0.10 x P100) 20,000
Remainder to ordinary (P80,000 – P60,000) 20,000
Total P60,000 P20,000

c. Dividends in arrears (1 x 2,000 x 0.10 x P100) P20,000

Current preferred dividends 20,000
Ordinary proportional share (0.10 x 30,000 x P10) P30,000
Remainder shared * (P80,000 – P70,000) 4,000 6,000
Total P44,000 P36,000
* Preference: P10,000 extra dividend x (2,000 x 100) / [(2,000 x 100) + (30,000 x 100)] = P4,000
* Ordinary: P10,000 extra dividend x 300,000 / 500,000 = P6,000

d. Preference dividend P20,000

Ordinary proportional share (0.10 x 30,000 x P10) P30,000
Preference extra (0.05 x P200,000) 10,000
Ordinary extra (0.05 x P300,000) 15,000
Remainder to ordinary (P80,000 – P75,000) 5,000
P30,000 P50,000

Requirement (2)
Dividend yield = Dividends per share / Market Price per share
Preference share: (P20,000 / 2,000) / P125 = P10 / P125 = 8%
Ordinary share: (P60,000 / 30,000) / P20 = P2 / P20 = 10%

Problem 4
Trading on the Equity Analysis Presented below is information from the annual report
of Empire Plastics, Inc.
Operating income P532,150
Bond interest expense 135,000
397,150
Income taxes 183,432
Net Income P213, 718

Bonds Payable P1,000,000

Ordinary Shares 875,000
Retained Earnings 375,000
Required:
Is Empire Plastics, Inc. trading on the equity successfully? Explain.
Answer:
Rate of return on equity:
P213,718 / (P875,000 + P375,000) = P213,718 / P1,250,000 = 17.1%
Rate of interest paid on bonds payable:
P135,000 / P1,000,000 = 13.5%
Emporia Plastics, Inc. is trading on the equity successfully, since its return on ordinary share
equity is greater than interest paid on bonds.

Problem 5: Shareholders’ Equity Section of the Statement of Financial Position

The following is a summary of all relevant transactions of MLA Corporation since it
was organized in 20X5.
In 20X5, 15,000 shares were authorized and 7,000 ordinary shares (P50 par value) were
issued at a price of P57. In 20X6, 1,000 shares were issued as a share dividend when the share
was selling for P62. Three hundred ordinary shares were bought in 20X6 at a cost of P66 per
share. These 300 shares are still in the company treasury.
In 20X5, 10,000 preference shares were authorized and the company issued 4,000 of
them (P100 par value) at P113. Some of the preference share was reacquired by the company
and later reissued for P4,700 more than it cost the company.
The corporation has earned a total of P610,000 in net income after income taxes and
paid out a total of P312,600 in cash dividends since incorporation.
Required:
Prepare the shareholders’ equity section of the statement of financial positon in proper
form for MLA Corporation as of December 31, 20X6. Account for treasury shares using the
cost method.

Answer:
MLA Corporation
SHAREHOLDERS’ EQUITY
December 31, 2007

Paid-in Capital:
Preference shares, P100 par value
10,000 shares authorized, 4,000 shares issued & outstanding P400,000
Ordinary shares, P50 par value
15,000 shares authorized,
8,000 shares issued 7,700 shares outstanding 400,000 P 800,000
Additional Paid-in Capital:
Paid-in capital in excess of par— preference 52,000
Paid-in capital in excess of par— ordinary 61,000
Paid-in capital from treasury shares— preference 4,700 117,700
Total Paid-in Capital 917,700
Retained Earnings: 235,400*
1,153,100
Less cost of treasury shares (300 shares—ordinary) 19,800
Total Shareholders’ Equity P1,133,300
*P610,000 – P312,600 – (P62 X 1,000 shares)
Problem 6: Issuance of Bonds and Warrants
Odyssey, Inc. has decided to raise additional capital by issuing P170,000 face value of
bonds with a coupon rate of 10%. In discussions with investment bankers, it was determined
that to help the sale of the bonds, detachable share warrants should be issued at the rate of one
warrant for each P100 bond sold. The value of the bonds without the warrants is considered to
be P136,000, and the value of the warrants in the market is P24,000. The bonds sold in the
market at issuance for P152,000.
Required:
(a) What entry should be made at the time of the issuance of the bonds and warrants?
(b) If the warrants were non-detachable, would the entries be different? Discuss.

Answer:
(a) Basic formulas:
Value of bonds without warrants / (Value of bonds without warrants + Value of warrants) X
Issue price = Value assigned to bonds
Value of warrants / (Value of bonds without warrants + Value of warrants) X Issue price =
Value assigned to warrants
P136,000 / (P136,000 + P24,000) X P152,000 = P129,200 Value assigned to bonds
P24,000 / (P136,000 + P24,000) X P152,000 = 22,800 Value assigned to warrants
P152,000 Total
Cash...................................................................... 152,000
Discount on Bonds Payable.................................. 40,800 (P170,000 – P129,200)
Bonds Payable.......................................... 170,000
Paid-in Capital—Share Warrants............. 22,800
(b) When the warrants are non-detachable, separate recognition is not given to the warrants. The
accounting treatment parallels that given convertible debt because the debt and equity
element cannot be separated.
The entry if warrants were non-detachable is:
Cash...................................................................... 152,000
Discount on Bonds Payable.................................. 18,000
Bonds Payable.......................................... 170,000

Problem 7: EPS with Convertible Bonds and Preference Shares

The Simmy Corporation issued 10-year, P5,000,000 par, 7% callable convertible
subordinated debentures on January 2, 20X7. The bonds have a par value of P1,000 with
interest payable annually. The current conversion ratio is 14:1, and in 2 years it will increase
into 18:1. At the date of issue, the bonds were sold at 98. Bond discount is amortized on a
straight-line basis. Simmy’s effective tax rate was 35%. Net income in 20X7 was P9,500,000,
and the company had 2,000,000 shares outstanding during the entire year.
Required:
(a) Prepare a schedule to compute both basic and diluted earnings per share.
(b) Discuss how the schedule would differ if the security was convertible preference share.

Answer:
Requirement (a)
Net income for year P9,500,000
Add: Adjustment for interest (net of tax) 234,000*
P9,734,000

* Maturity value P5,000,000

 Stated rate X 7%
Cash interest 350,000
Discount amortization [(1.00 – .98) X P5,000,000 X 1/10] 10,000
Interest expense 360,000
1 – tax rate (35%) X 0.65
After-tax interest P 234,000

P5,000,000/P1,000 = 5,000 debentures

Increase in diluted earnings per share denominator:
5,000 X 18 = 90,000
Earnings per share:
Basic EPS P9,500,000 ÷ 2,000,000 = P4.75
Diluted EPS P9,734,000 ÷ 2,090,000 = P4.66

Requirement (b)
If the convertible security were preference shares, basic EPS would be the same assuming
there were no preference dividends declared or the preference was noncumulative. For diluted EPS,
the numerator would be the net income amount and the denominator would be 2,090,000.

Problem 8
You are engaged in the audit of Phoenix, Corp., a new client, at the close of its first fiscal
year, April 30, 20X1. The accounts had been closed before the time you began your year-end
filed work.
You review the following stockholders’ equity accounts in the general ledger:
Capital Stock
5/1/X0 CR1
500,000
4/28/X1 J12-5
50,000

Paid-in Capital in Excess of Stated Value

5/1/X0 CR1
250,000
2/2/X1 CR10
2,500

Retained Earnings
4/28/X1 J12-5 4/30/X1 J12-12
50,000 800,000

Treasury Stock
9/14/X0 CP5 2/2/X1 CR10
80,000 40,000

Income Summary
4/30/X1 J12-13 4/30/X1 J12-12
5,200,000 6,000,000
4/30/X1 J12-14
800,000
Other information in your working paper includes the following:
1. Phoenix’s articles of incorporation filed April 17, 20X0, authorized 100,000 of non-par
value capital stock.
2. Directors’ minutes include the following resolutions:
4/18/X0 Established P50 per share stated value for capital stock.
4/30/X0 Authorized issue of 10,000 shares to an underwriting syndicate for P75 per
share.
9/13/X0 Authorized acquisition of 1,000 shares from a dissident holder at P80 per
share.
2/01/X1 Authorized reissue of 500 treasury shares at P85 per share.
4/28/X1 Declared 10 percent stock dividend, payable May 18, 20X1, to stockholders of
record May 4, 20X1.
3. The following costs of the May 1, 20X0, and February 2, 20X1, stock issuances were
charged to the named expensed accounts; Printing Expense, P2,500. Legal Fees,
P17,350; Accounting Fees, P12,000; and SEC Fees, P150.
4. Market values for Phoenix Corp. capital stock on various dates were
9/13/X0 P78.50 2/02/X1 P85.00
9/14/X0 P79.00 2/28/X1 P90.00
5. Phoenix Corp.’s combined federal and state income tax rates total 55 percent.
Required:
a. Prepare the necessary adjusting journal entries at April 30, 20X1.
b. Prepare the stockholders’ equity section of Phoenix Corp.’s April 30, 20X1, balance
sheet.

Answer:
Requirement (a)
The first journal entry would be to charge the costs to stock issuances to the
appropriate account heads. Costs such as printing expenses, legal fees, accounting fees and the
SEC filing fees should be charged to the paid-in-capital in excess of stated value. Direct costs
incurred to sell shares, such as underwriting costs, accounting and legal fees, printing costs,
and taxes, should reduce the proceeds received from the sale of the shares. To record the
journal entry, debit paid-in capital in addition of stated value and credit the individual costs
accounts with respective amounts as below:
Dat Account Title Debit Credit
e
Paid-in Capital in addition of stated value 32,00
0
Printing Expense 2,500
Legal Fees 17,350
Accounting Fees 12,000
SEC Fees 150
To assign the costs of May 1, 20X0 and February 2, 20X1 to
paid-in capital account