Equity – also known as net assets; residual interest in the assets of the company after considering liabilities

(assets less liabilities)

Requirements of an equity:
1. The instrument includes no contractual obligations
a. To deliver cash or another financial asset to another entity; or
b. To exchange financial instruments with another entity under potentially unfavorable conditions
2. If the instrument will be settled in the company’s own equity instruments:
a. it should be a non-derivative that includes no contractual obligation to deliver a variable
number of its own equity instruments; or
b. a derivative that will be settled only by the issuer exchanging a fixed amount of cash or another
financial asset for a fixed number of its own equity instruments

Example 1:
ABC Co. issued preference shares. The shares are to be redeemed on or before December 31, 2025 by ABC.

Classification: Since the company has the obligation to redeem (by paying cash or another financial asset) –
liability

Example 2:
ABC Co. entered into an instrument to deliver 5,000 shares of its own equity instruments.

Classification: Since the company will deliver fixed number of own equity instruments – equity

Example 3:
ABC Co. entered into an instrument to deliver P50,000 worth of its own equity instruments based on the
market price of the instrument upon delivery.

Classification: Since the company will deliver variable number of own equity instruments derived from the
market price – liability

Components of equity
1. Share capital (at par value if with par value; if no par value – measured at stated value if with state
value; if no stated value – measured at total consideration)
a. Issued share capital – par value of shares issued
b. Subscribed share capital – par value of shares subscribed but not yet issued (not yet fully paid)
c. Share dividends distributable – par value of share dividends already declared but not yet
distributed
2. Share premium
a. Excess over par value (from issuance of shares)
b. Excess over cost (from re-issuance of treasury shares)
c. Due to retirement of shares
d. Donated capital
e. Special assessments
f. Share options outstanding
g. Share warrants outstanding
3. Accumulated profits or Retained earnings
a. Unappropriated or free
b. Appropriated
a. Legal appropriations – required by law such as appropriation for treasury shares
b. Contractual appropriations – required by contracts such as loan covenants
c. Voluntary appropriations – appropriations as decided by the board of directors such as
appropriation for plant expansion
4. Other Comprehensive Income (CUTERR)
a. Credit risk of financial liabilities at FVPL
b. Unrealized gain of financial assets at FVOCI
c. Translation adjustment under IAS 21
d. Effective portion of cash flow hedges
e. Revaluation surplus
f. Remeasurement of net retirement benefit obligation under IAS 19
5. Treasury shares – contra-equity account
Problem 1:
The shareholders’ equity section of Armani Corporation’s statement of financial position as of December 31,
2021 (beginning balances), is as follows:

Ordinary share capital (P6 par, 250,000 shares authorized,

147,500 issued and outstanding) P885,000
Share premium 442,500
Total paid-in capital P1,327,500

Unappropriated retained earnings P 963,500

Appropriated retained earnings 350,000
Total retained earnings P1,313,500
Total shareholders’ equity P2,641,000

Armani Corporation had the following shareholders’ equity transactions during 2022:

Jan. 15 Completed the building renovation for which P350,000 of retained earnings had been restricted
(voluntary appropriation, since the reason for the appropriation is already finished, we need to
reverse the appropriation). Paid the contractor P328,300, all of which is capitalized.

Building 328,300
Cash 328,300
To record payment to the contractor

Appropriated RE 350,000
Unappropriated RE 350,000
To record reversal of appropriation

Mar. 3 Issued 50,000 additional ordinary shares for P11 per share.

Cash (50,000 x P11) 550,000

Share Capital – Ordinary (50,000 x P6) 300,000
Share Premium – Ordinary 250,000

May 18 Declared a dividend of P1.50 per share to be paid on July 31, 2022, to shareholders of record on
June 30, 2022.
Number of shares outstanding, January 1 147,500
Issuance of shares of March 3 50,000
Number of shares outstanding, May 18 197,500
Multiply: Dividend per share x1.50
Amounts of dividends to be paid 296,250

Unappropriated RE 296,250
Cash Dividends Payable 296,250
June 19 Approved additional building renovation to be funded internationally internally. The estimated cost
of the project is P400,000, and retained earnings are to be restricted for that amount.

Unappropriated RE 400,000
Appropriated RE 400,000

July 31 Paid the dividend.

Cash Dividends Payable 296,250

Cash 296,250

Nov. 12 Declared a property dividend (IFRIC 17) to be paid on December 31, 2022, to shareholders of record
on November 30, 2022. The dividend is to consist of 18,300 shares of Chanel Corporation ordinary
shares that are currently recorded in Armani’s books at P9 per share. (property dividends should be
measured at fair value, since the problem did not provide for fair value, we use the P9 per share)

Unappropriated RE (18,300 x P9) 164,700

Property Dividend Payable 164,700
To record property dividend declared at fair value on date of declaration

Dec. 31 Reported P673,500 of net income on December 31, 2022 income statement. In addition, the shares
were distributed in satisfaction of the property dividend.

Unappropriated RE 0
Property Dividend Payable 0
To adjust the property dividend payable to the fair value as of December 31

Property Dividend Payable 164,700

Investment in Chanel 164,700
Gain (if not balanced) 0

Income Summary 673,500

Unappropriated RE 673,500

Required:
1. Prepare the journal entries to record the transactions in 2022.
2. Determine the balance of the following as of December 31, 2022:
a) Ordinary share capital account
b) Share premium account
c) Unappropriated retained earnings
d) Total shareholders’ equity

Accounting for property dividends

Date of declaration – recognize property dividend payable (liability account) with corresponding debit to
Unappropriated RE at fair value on date of declaration; no adjustment for the carrying value of the non-
cash asset

If not yet distributed, at year-end:

 • Remeasure the property dividend to fair value (adjust property dividend payable with corresponding
adjustment to unappropriated RE)
• Non-cash asset is accounted for using the applicable accounting standard
o Example: inventories – IAS 2 (LCNRV); investment in shares – IFRS 9 (FV either through
P/L or OCI); PPE – IFRS 5, Non-current Assets Held for Sale, not IAS 16

On date of distribution:
• Remeasure the property dividend to fair value (adjust property dividend payable with corresponding
adjustment to unappropriated RE)
• Difference between the property dividend payable (at fair value) and the non-cash asset (at carrying
amount) is recognized in profit or loss

Problem 2:
Fleurage Inc. is a public enterprise whose shares are traded in the over the counter market. At December 31,
2021, Fleurage had 6,000,000 authorized shares of P10 par value common stock, of which 2,800,000 shares
were issued and outstanding. The stockholders’ equity accounts at December 31, 2021 (beginning balance), had
the following balances.

Share Capital – Ordinary P28,000,000

Share Premium – Ordinary (11.5M divided by 2.8M = 4.107
per share) 11,500,000
Retained earnings 8,450,000

Transactions during 2022 and other information relating to the stockholders’ equity accounts were as follows:

 On January 5, 2022, Fleurage issued at P56 per share, 125,000 shares of P50 par value, 9% cumulative
convertible preferred stock. Each share of preferred stock is convertible, at the option of the holder, into
two shares of common stock. Fleurage had 600,000 authorized shares of preferred stock. The preferred
stock has a liquidation value equal to 125% of its par value.

1/5/2022 Cash (125,000 shares x P56) 7,000,000

Share Capital – Preference (125,000 x P50) 6,250,000
Share Premium – Preference 750,000

 On February 1, 2022, Fleurage reacquired 25,000 shares of its (since own shares, treasury shares) common
stock for P16 per share, Fleurage uses the cost method to account for treasury stock.

2/1/2022 Treasury Shares (25,000 x P16) 400,000

Cash 400,000

 On April 30, 2022, Fleurage sold 650,000 shares (previously unissued) (not from treasury) of P10 par value
common stock to the public at P17 per share.

4/30/2022 Cash (650,000 x P17) 11,050,000

Share Capital – Ordinary (650,000 x P10) 6,500,000
Share Premium – Ordinary 4,550,000

 On May 13, 2022, Fleurage issued 540,000 stock rights (rights to purchase shares in the future at a fixed
price or predetermined price or exercise price). Five rights, plus P30 in cash (exercise price), are required
 to purchase one new Fleurage ordinary share. On the date of issuance, Fleurage stock was selling for P75
per share.

5/13/2022 Memo entry

 On June 18, 2022, Fleurage declared a cash dividend of P1.50 per share of common stock, payable on July
12, 2022, to stockholders’ record on July 1, 2022.

Beginning outstanding shares 2,800,000

Reacquired as treasury – 2/1/2022 (25,000)
Issuance – 4/30/2022 650,000
Outstanding shares as of June 18 3,425,000
Dividend per share x1.50
Dividends declared 5,137,500

6/18/2022 Retained Earnings – Free 5,137,500

Cash Dividends Payable 5,137,500

7/1/2022 Memo Entry

7/12/2022 Cash Dividends Payable 5,137,500

Cash 5,137,500

 On November 10, 2022, Fleurage sold 10,000 shares of treasury stock for P24 per share

11/10/2022 Cash (10,000 x P24) 240,000

Treasury Shares (10,000 x P16) 160,000
Share Premium – Treasury 80,000

 On December 14, 2022, Fleurage declared the yearly cash dividend on preferred stock, payable on January
14, 2023, to stockholders of record on December 31, 2022.

12/14/2022 Retained Earnings – Free 562,500

Cash Dividends Payable 562,500
(6,250,000 preference share capital x 9% dividend rate)

Preference shares issued 125,000 shares

Preference shares subscribed 0 shares
Preference shares in treasury (0 shares)
Preference shares outstanding, 12/14/2022 125,000 shares
Par value xP50 per share
Par value of shares outstanding P6,250,000
Dividend rate x9%
Dividends P562,500

12/31/2022 Memo Entry

 On January 20, 2023 (adjusting entry as of year-end), before the books were closed for 2022, Fleurage
became aware that the ending inventories at December 31, 2021 were understated by P300,000 (gross of
tax; where income tax rate is 30%). The appropriate correction entry was recorded the same day.
12/31/2022 Inventory 12/31/2021 300,000
Retained Earnings – Free (300,000 x 70%) 210,000
Income Tax Payable 90,000
The credit to RE is due to understated ending inventory last year causing NI last year to be understated

 After correcting the beginning inventory, net income for 2022 was P5,750,000.

12/31/2022 Income Summary 5,750,000

Retained Earnings – Free 5,750,000

12/31/2022 Retained Earnings – Free 240,000

Retained Earnings – Appropriated 240,000
To record appropriation of retained earnings due to treasury shares

Required: Compute for the following:

1) Retained earnings – unappropriated 8,470,000
2) Stockholders’ equity 66,100,000
3) Book value per share of common (Dec. 31, 2022) 16.97
 OSC PSC SP-OS SP-PS SP-TS RE-F RE-A (TS) SHE
Beginning 28,000,000 0 11,500,000 0 0 8,450,000 0 0 47,950,000
1/5/2022 6,250,000 750,000 7,000,000
2/1/2022 400,000 (400,000)
4/30/2022 6,500,000 4,550,000 11,050,000
6/18/2022 (5,137,500) (5,137,500)
11/10/2022 80,000 (160,000) 240,000
12/14/2022 (562,500) (562,500)
12/31/2022 210,000 210,000
12/31/2022 5,750,000 5,750,000
12/31/2022 (240,000) 240,000 0
Ending 34,500,000 6,250,000 16,050,000 750,000 80,000 8,470,000 240,000 240,000 66,100,000

Under BVPS – we assume that the assets and liabilities are liquidated at book values.
BVPS = how much each stockholder will receive if the company liquidates today at book value?
• Subscription receivable is ignored in the equity section (do not consider as contra-equity)
• Treasury shares are assumed to be retired.

Journal entry for the assumed retirement of treasury shares:

Ordinary Share Capital (15,000 shares x P10) 150,000
SP – OS (max 15,000 x 4.107 = 61,605) 61,605 (mauubos)
SP – TS (max 80,000) 28,395
Treasury Shares 240,000

Balancing figure:
I. SP – original issuance (4.107 per share)
II. SP – treasury
III. RE – free

OSC PSC SP-OS SP-PS SP-TS RE-F RE-A (TS) SHE

Ending 34,500,000 6,250,000 16,050,000 750,000 80,000 8,470,000 240,000 240,000 66,100,000
Assumed (150,000) (61,605) (28,395) (240,000) 0
retirement
For BVPS 34,350,000 6,250,000 15,988,395 750,000 51,605 8,470,000 240,000 0 66,100,000

Ordinary Shares Preference Shares Excess

For BVPS 34,350,000 6,250,000 25,500,000 Commented [AT1]: Par value of preference
If cumulative: dividend in arrears 0 (0)
Liquidation premium 1,562,500 (1,562,500)
Balance 23,937,500
If participating: allocate to OS and PS, if not, all to OS 23,937,500 (23,937,500)
Total 58,287,500 7,812,500
Divide: # of shares outstanding (for BVPS divided by par value per share) 3,435,000 125,000
BVPS 16.97 62.50

NOTE: Zero dividend in arrears because the company has paid the required annual dividends of the preference
shares.
Liquidation value per share (125% x P50) 62.50
Par value (50.00)
Liquidation premium per share 12.50
# of preference shares outstanding x125,000
Liquidation premium 1,562,500
If the treasury shares are re-issued at loss (amount lower than cost):
The balancing debit or the loss will be debited to:
I. SP – TS of the same class
II. RE - unappropriated

Problem 3:
You were assigned to audit the financial statements of Very Basic Company dated December 31, 2022. You
were provided with the following 2022 year-end balances (ending balances) from its post-closing trial balance
(income statement accounts are already closed to retained earnings):
Share Capital – Preference (6%, P50 par, 10,000 shares authorized) P500,000
Share Capital – Ordinary (P100 par value, 50,000 shares authorized) 2,500,000
Subscribed Share Capital – Ordinary 1,000,000
Share Premium 500,000
Other comprehensive income 800,000
Retained Earnings 5,200,000
Treasury Shares (3,000 shares at cost) (255,000)
Total P10,245,000
In the course of your audit, you noticed several transactions which requires further analysis:

(a) Treasury shares pertain to SMC shares acquired in June (shares of another entity = investments, and not
treasury shares). The fair value of these shares at December 31, 2022 amounted to P75 per share. The
company holds several similar investments that are held for purposes of trading (should be FVPL).

PC PA PAJE
Treasury shares 255,000 FVPL 255,000 FVPL 255,000
Cash (255,000) Cash (255,000) Treasury shares (255,000)

No entry RE (UL) 30,000 RE (UL) 30,000

FVPL (30,000) FVPL (30,000)

(b) The corporation received donations during the year in the form of supplies from a non-stockholder
(donation from non-stockholder is recognized as gain) worth P1,000,000. Said amount was unconditional
and remained unrecorded as of year-end.

PC PA PAJE
No entry Supplies 1,000,000 Supplies 1,000,000
RE (Gain on donation) (1,000,000) RE (Gain on donation) (1,000,000)

(c) “The Share Capital – Preference” account was originally issued at par (no share premium). It has a
mandatory redemption (contractual obligation to redeem at a specified time = liability) by the issuer for
P600,000. The dividend for the year was already declared and paid.

PC PA PAJE
Cash 500,000 Cash 500,000 Preference Share Capital 500,000
Preference Share Capital (500,000) Liability (500,000) Liability (500,000)

Retained Earnings 30,000 RE (Interest Expense) 30,000 No entry

Cash (30,000) Cash (30,000)
(d) 5,000 shares (donated shares = memo entry) of Very Basic Company were received from a shareholder in
the last quarter of the year. These shares were still unrecorded as of year-end.

PC PA PAJE
No entry Memo entry Memo entry

If the donated shares are re-issued, the journal entry is:

Dr. Cash XX
Cr. SP – Donated XX

(e) P300,000 worth of assessment (additional investment by stockholders, without shares) was levied on
shareholders during the year. The said amount was included as part of the retained earnings.

PC PA PAJE
Cash 300,000 Cash 300,000 Retained Earnings 300,000
Retained Earnings (300,000) SP – Donated (300,000) SP – Donated (300,000)

(f) 10% convertible bonds payable with a face value of P1,000,000 and a remaining unamortized discount of
P150,000 were converted to 5,000 ordinary shares at the last day of the calendar year. Interest are paid
annually every December 31. The share premium account includes bond conversion privilege amounting
to P50,000 (computation of SP – conversion privilege will be tackled in liabilities discussion). After paying
for interest, the conversion was recorded by the client by debiting bonds payable amounting to P1,000,000
and by crediting share premium P1,000,000.

PC PA PAJE
Bonds Payable 1,000,000 Bonds Payable 1,000,000 SP 150,000
Share Premium (1,000,000) SP – Conversion Privilege 50,000 Discount on Bonds Payable (150,000)
Discount on Bonds Payable (150,000)
SP – Ordinary (900,000)

(g) During the year, an equipment originally acquired in January 1, 2018 at P9,520,000 and with an estimated
useful life of 8 years was revalued in January 1, 2022 (should be December 31, 2021). Its sound value on
that date was P8,750,000. Also on that date, the total estimated useful life changed from 8 years to 10 years
(revised remaining life as of December 31, 2021 = 10 years – 4 years depreciated = 6 remaining life). The
entity uses the straight line method in depreciating this equipment. The client recorded the revaluation by
debiting equipment and crediting retained earnings for P1,250,000. The client recorded depreciation in the
amount of P1,750,000.

Before Revaluation After Revaluation Effect of Revaluation

Gross 9,520,000
Accumulated Depreciation (4,760,000)
Carrying value 4,760,000 8,750,000 3,990,000
NOTE: We will be using the elimination method to record revaluation.

PC PA PAJE
Equipment 1,250,000 Accumulated 3,990,000 Accumulated 3,990,000
Retained Earnings (1,250,000) Revaluation Surplus – OCI (3,990,000) Retained Earnings 1,250,000
Equipment (1,250,000)
Revaluation Surplus – OCI (3,990,000)

RE (Depreciation) 1,750,000 RE (Depreciation) 1,458,333 Accumulated 291,667

 Accumulated (1,750,000) Accumulated (1,458,333) RE (Depreciation) (291,667)

Revaluation Surplus – OCI 665,000 Revaluation Surplus – OCI 665,000

RE (665,000) RE (665,000)

(h) At year-end, you received an information that the company’s net defined benefit liability increased from
P600,000 to P900,000 during the year. Contributions during the year amounted to P500,000 and the
amount of benefit expense is P1,800,000. The client recorded this by debiting pension liability and crediting
cash for P500,000. (skip)

PC PA PAJE
Pension Liability 500,000 Pension Liability 500,000 No entry
Cash (500,000) Cash (500,000)

No entry RE (Benefit Expense) 1,800,000 RE (Benefit Expense) 1,800,000

Pension Liability (1,800,000) Pension Liability (1,800,000)

(i) The entity received a land from a shareholder as a donation with a fair value of P2,000,000. The entity
spent P200,000 for registration fees and legal fees (if from stockholder – deduction to share premium) in
connection with the property. It was recorded by the client by debiting land and crediting retained earnings
for P2,000,000. The registration fee paid was charged to expense.

PC PA PAJE
Land 2,000,000 Land 2,000,000 Retained Earnings 2,000,000
Retained Earnings (2,000,000) SP – Donated (2,000,000) SP – Donated (2,000,000)

RE (Expense) 200,000 SP – Donated 200,000 SP – Donated 200,000

Cash (200,000) Cash (200,000) RE (Expense) (200,000)

(j) The entity reissued 3,000 of the shares received as a donation for P110. The entity recorded it by crediting
share capital for 300,000 and share premium for P30,000.

PC PA PAJE
Cash 330,000 Cash 330,000 Share Capital 300,000
Share Capital (300,000) SP – Donated (330,000) SP (300,000)
SP (30,000)

(k) The subscribed share capital pertains to 8,000 shares. These shares were already fully paid and issued
(reclassification from subscribed share capital to share capital) during December. The collection was
properly recorded but the client failed to record the issuance.

PC PA PAJE
Cash XX Cash XX No entry
Subscription Receivable (XX) Subscription Receivable (XX)

No entry Subscribed Share Capital – Ordinary 1,000,000 Subscribed Share Capital – Ordinary 1,000,000
Share Capital – Ordinary (1,000,000) Share Capital – Ordinary (1,000,000)

(l) The entity declared a 10% share dividends in the previous year amounting to P300,000 and was distributed
on January of the current year. The amount based on the fair value of the shares at the time of declaration.
The entry to debit retained earnings was recorded in January of the current year.

Rules on declaration of stock dividends/bonus issue:

If the stock dividend declared is a small stock dividend (less than 20%) = measure the debit to retained earnings
at fair value at date of declaration
If the stock dividend declared is a large stock dividend (at least 20% or 20% or more) = measure the debit to
retained earnings at par value of the shares

PC PA PAJE
Retained Earnings 300,000 Retained Earnings 300,000 No entry as of year-end (correct as of year-end)
Share Capital (at par) (XX) Share Capital (at par) (XX) As of last year, incorrect.
Share Premium (XX) Share Premium (XX)

Required: Prepare an audit working paper to arrive at the corrected balances of the shareholders’ equity the
accounts as of December 31, 2022.

Share capital Share capital Subscribed Share OCI RE TS Total

– ordinary – preference share capital – Premium
ordinary
Unadjusted 500,000 2,500,000 1,000,000 500,000 800,000 5,200,000 (255,000) 10,245,000
Item (a) (30,000) 255,000 225,000

Problem 4:
The Unappropriated Accumulated Profit account of BISTRO CO. shows the following debits and credits for
the year 2022:
UNAPPROPRIATED ACCUMULATED PROFITS
Description Debit Credit Balance
Balance, Beg. 565,500
Gain on life insurance policy settlement (should be part of net
a) income) 50,000 615,500
Write-off of goodwill (should be part of net income –
b) impairment of goodwill) 30,000 585,500
Effect of change in accounting policy from FIFO to weighted
c) average (change in policy – retroactive adjustment) 100,000 685,500
Loss on sale of treasury shares (Share Premium is sufficient to
d) cover the loss) (debited to SP) 20,000 665,500
10% share dividends on 100,000, P10 par value shares issued
and outstanding (Fair Value at the same date at P12.50) (small
bonus issue at fair value = 100,000 shares x 10% dividend rate
e) x P12.50 = 125,000) 100,000 565,500
Officers' compensation related to income of prior periods
f) (correction of prior period error) - accrual overlooked 160,000 405,500
g) Premium on ordinary shares issued (share premium) 65,000 470,500
Share issuance expenses (related to ordinary shares issued) –
share issue costs are deducted from I. SP – same class of shares
h) (until maubos), II. RE 5,000 465,500
Share subscription defaults – credited to SP (already paid up is
i) not refunded) 15,000 480,500
j) Loss on sale of equipment (should be part of net income) 25,000 455,500
Gain on retirement of preference shares at less than issue price
k) (share premium) 35,000 490,500
 Gain on early retirement of bonds (should be part of net
l) income) 12,500 503,000
m) Correction of a prior period error (retroactive) 45,000 548,000
n) Cash dividends declared 75,000 473,000
o) Inventory loss from flood (should be part of net income) 10,500 462,500
p) Proceeds from sale of donated shares (part of share premium) 37,500 500,000
q) Revaluation increase in land (part of OCI) 150,000 650,000
r) Appropriation for plant expansion 100,000 550,000
s) Net income for the period 175,000 725,000
Required:
1. How much is the correct unappropriated accumulated profits restated (restatement due to: (1) correction
of errors; (2) change in accounting policies such as change in inventory valuation from FIFO to average
and (3) transition to new accounting standards) beginning balance?
2. How much is the adjusted net income for the year?
3. How much is the correct unappropriated accumulated profits ending balance?

Retained Earnings NI Retained Earnings

unappropriated, Beg unappropriated, End
Unadjusted 565,500 175,000 725,000
(a) 50,000
(b) (30,000)
(c) 100,000
(d) 20,000
(e) (25,000)
(f) (160,000)
(g) (65,000)
(h) 5,000
(i) (15,000)
(j) (25,000)
(k) (35,000)
(l) 12,500
(m) 45,000
(n)
(o) (10,500)
(p) (37,500)
(q) (150,000)
(r)
(s)
Adjusted 550,500 172,000 422,500

Alternative solution:
Retained earnings – unappropriated, beginning (as reported) 565,500
Restatements:
Change in policy from FIFO to average 100,000
Correction of prior period errors (160,000 – 45,000) (115,000)
Retained earnings, beginning (as restated) 550,500
Adjusted net income for 2022 172,000
Dividends declared during 2022
Stock dividends at fair value (125,000)
Cash dividends (75,000)
 Appropriation due to plant expansion (100,000)
Retained earnings – unappropriated, ending 422,500

Share-based payments (IFRS 2)

1. Equity-settled share-based payment – company will be issuing its own equity instruments in the future
(example: option to purchase company’s shares at a pre-determined exercise price); classification:
equity
2. Cash-settled share-based payment – company will be paying cash (amount is based on the value of the
shares); classification: liability

Equity-settled share-based payment

• Valuation: based on the fair value on grant date (except if fair value cannot be determined reliably:
intrinsic value)
• Journal entry:
Compensation Expense XX
Share Premium – Share Options Outstanding XX

• Once options are exercised:

Cash (at exercise price) XX
SP – SOO XX
Share Capital XX
SP – Issuance XX

Problem 5:
At the beginning of 2021, Lancome Company grants share options to each of its 100 employees working in the
sales department. The share options will vest at the end of 2023 (vesting period), provided that the employees
remain in the entity’s employ, and provided that the volume of sales of a particular product increases by at least
an average of 5 percent per year. If the volume of sales of the product increases by an average of between 10
percent and 15 percent each year, each employee will receive 300 share options. If the volume of sales increases
by an average of 15% or more, each employee will receive 400 share options.

On grant date, Lancome Company estimates that the share options have a fair value of P34 per option.
Lancome Company also estimates that the volume of sales of the product will increase by an average of between
10% and 15% per year. The company also estimates on the basis of weighted average probability that 19% of
employees will leave before the end of 2021.

By the end of 2021, seven employees have left and the company still expects that a total of 19 employees
(estimated aalis for the entire period – expected to leave in 2022 and 2023 = 12) will leave by the end of 2023.
Product sales have increased by 12% and the company expects this rate of increase to continue over the next
two years.

By the end of 2022, a further six employees have left. The entity now expects only four more employees will
leave during 2023. Product sales have increased by 18%. The company now expects that sales will average
15% or more over the three-year period.

By the end of 2023, a further three employees have left. The entity’s sales have increased by an average of 16%
over the three years.

Required: Compute for the following

1. Compensation expense, 2021
2. Compensation expense, 2022
3. Compensation expense, 2023

2021 2022 2023

Total # of employees at the start 100 100 100
Employees who have actually left to date (umalis na) (7) (13) (16)
Estimated # of employees who will leave in the future (aalis pa) (12) (4) (0)
Estimated # of employees who will be entitled to the options (matitira) 81 83 84
# of options per employee x300 x400 x400
Estimated # of options to be issued on 12/31/2023 24,300 33,200 33,600
FV on grant date per option x34 x34 x34
Estimated value of options to be issued 826,200 1,128,800 1,142,400
% vested (parang percentage of completion) x1/3 x2/3 x3/3
Cumulative expense – Share Options Outstanding 275,400 752,533 1,142,400
Beginning SOO/PY SOO (0) (275,400) (752,533)
Expense during the year 275,400 477,133 389,867

2021 Compensation Expense 275,400

SP – SOO 275,400

2022 Compensation Expense 477,133

SP – SOO 477,133

2023 Compensation Expense 389,867

SP – SOO 389,867

SP – SOO
1/1/2021 0
2021 expense 275,400
12/31/2021 275,400
2022 expense 477,133
12/31/2022 752,533
2023 expense 389,867
12/31/2023 1,142,400

Share Appreciation Rights – employee will receive the amount of the appreciation or increase in the share
price from a pre-determined price
For example: pre-determined price is P5. If the share price increases to P30, the employee will receive P25
(intrinsic value) in cash per right.

Problem 6:
On January 1, 2019, Royce Corporation grants 120 cash share appreciation rights (SAR) (cash-settled share-
based payment valued at fair value at year-end) to each of its 200 employees on condition that the employee
remain in its employ for the next three years.
During 2019, 14 employees left and the company estimates that a further 24 will leave during 2020 and 2021.
During 2020, 10 employees left and the company estimates that a further 8 will leave during 2021. During 2021,
8 employees left. At the end of 2021, 60 employees exercised their SAR. At the end of 2022, another 40
employees exercised their SAR. At the end of 2023, the remaining employees exercised their SAR.

The entity estimates the fair value of the SAR at the end of each year in which a liability exists as show below.
At the end of 2021, all SAR held by the remaining employees vest. The intrinsic values of the SAR at the date
of exercise (which equal the cash paid out) at the end of 2021, 2022, and 2023 are also shown below:

Year Fair Value Intrinsic Value

2019 P 28
2020 30
2021 33 P 36
2022 41 39
2023 48

Required: Compute for the following

1. Compensation expense in 2019
2. Compensation expense in 2020
3. Compensation expense in 2021
4. Compensation expense in 2022
5. Compensation expense in 2023

2019 2020 2021 2022 2023

# of employees 200 200 200 200 200
# of employees who have left (to date) (14) (24) (32) (32) (32)
# of employees who will still leave before vesting (24) (8) (0) (0) (0)
# of employees who exercised their rights (to date) (0) (0) (60) (100) (168)
# of employees who still have rights as of year-end 162 168 108 68 0
# of rights per employee x120 x120 x120 x120 x120
# of estimated rights remaining as of year-end 19,440 20,160 12,960 8,160 0
Fair value at year-end x28 x30 x33 x41
Total value of rights still outstanding 544,320 604,800 427,680 334,560 0
% vested x1/3 x2/3 x3/3 x3/3
Liability balance 181,440 403,200 427,680 334,560
 Liability (SARs)
1/1/2019 balance 0
2019 payments at intrinsic value 0 2019 expense 181,440
12/31/2019 balance 181,440
2020 payments at intrinsic value 0 2020 expense 221,760
12/31/2020 balance 403,200
2021 payments at intrinsic value
(60 emp x 120 rights x P36 per right) 259,200 2021 expense 283,680
12/31/2021 balance 427,680
2022 payments at intrinsic value
(40 emp x 120 rights x P39) 187,200 2022 expense 94,080
12/31/2022 balance 334,560
2023 payments at intrinsic value
(68 emp x 120 rights x P48) 391,680 2023 expense 57,120
12/31/2023 balance 0

Pro-forma entries:
Compensation Expense XX
Liability – Share Appreciation Rights XX
To record expense for the year

Liability – Share Appreciation Rights XX

Cash XX
To record payments at intrinsic value

Intrinsic value – amount to be received if the rights are exercised today (actual price appreciation or
increase of the shares)
Fair value – intrinsic value + adjustment for the future/time value (expected price appreciation if exercised in
the future)

Problem 7:
Titus Company grants to an employee the right to choose either 5,500 phantom shares (employee will receive
the cash price equivalent of the shares, employee does not actually the shares = liability account) or 7,000 shares
(employee receives the shares equity account). The grant is conditional upon the completion of three years of
service. If the employee chooses the share alternative, the shares must be held for three years after the vesting
date.

At grant date, the entity’s share price is P83 per share (intrinsic value of the liability component). At the end
of years 1, 2 and 3, the share price is P84, P87 and P91 respectively. The entity does not expect to pay dividends
in the next three years. After taking into account the effects of the post-vesting transfer restrictions, the entity
estimates that the grant date fair value of the share alternative is P81 per share.

Required: Compute for the following

1. Compensation expense, year 1
2. Compensation expense, year 2
3. Compensation expense, year 3
 Total value of the share alternative (P81 per share x 7,000 shares) 567,000
Liability component as of grant date (P83 per share x 5,500 phantom shares) (456,500)
Residual – equity component 110,500

The fair value of the liability component is not given, if the fair value cannot be determined, we will use the
intrinsic value

Since the equity component is measured at fair value on grant date and there are no changes in estimates
such as change in number of employees, change in number of shares to be issued, the equity component is
recognized as expense on a straight-line basis (110,500 divided by 3-year vesting period = 36,833 per year)

Y1 Y2 Y3
# of phantom shares to be issued 5,500 5,500 5,500
Intrinsic value (since FV is not given) per share x84 x87 x91
Value of phantom shares to be issued 462,000 478,500 500,500
% vested x1/3 x2/3 x3/3
Liability account 154,000 319,000 500,500
PY liability (154,000) (319,000)
Expense – liability component 154,000 165,000 181,500
Expense – equity component 36,833 36,833 36,833
Total expense 190,833 201,833 218,333

Journal entries:
Y1 Compensation Expense 190,833
Liability 154,000
SP – Share Alternative 36,833

Y2 Compensation Expense 201,833

Liability 165,000
SP – Share Alternative 36,833

Y3 Compensation Expense 218,333

Liability 181,500
SP – Share Alternative 36,833

Assuming that the employee chooses the share alternative

Liability 500,500
SP – Share Alternative 110,500
Share Capital (7,000 shares x par) 70,000 (assumed par = P10)
SP – Issuance 541,000

Assuming that the employee chooses the cash alternative

Liability 500,500
Cash 500,500

SP – Share Alternative 110,500

 SP – Issuance 110,500

Audit of equity – other than P/L and OCI, there are generally limited transactions

General approach of the auditor: perform test of details of transactions

• For the transactions, auditor will be vouching the transaction back to the minutes of the meeting
for proper approval
• Inspect the articles of incorporation and by-laws (for recurring audits, we can refer to the permanent
file)
• Retained Earnings Reconciliation (common reconciling items will include CAJEs that are not posted,
PAJEs); beginning RE should equal the RE in the audited financial statements
• Inspect minutes of the meetings for any unusual items that would warrant journal entries such as
appropriations
• Inquiry with management and those charged with governance