8

AUDIT OF
SHAREHOLDERS' EQUITY
AUDIT PROGRAM FOR STOCKHOLDERS' EQUITY
Audit Objectives
To determine that:
a. Proper authorization of transactions involving stockholders' equity accounts
b. Proper accounting treatment of transactions involving stockholders' equity.
c. Compliance with legal requirements related to corporate capitalization.
d. Propriety of financial statement presentation and adequacy of disclosures.

Audit Procedures
1. Obtain a copy of the latest articles of incorporation and determine for each class of stock:
a. Authorized capital stock
b. Par or stated value
c. Preferences and limitations, if any.

2. Obtain or prepare a schedule of the capital stock, subscribed capital stock, and treasury stock
accounts indicating the number of shares and amounts for the:
a. Beginning of the year balances
b. Additions and deductions for the current year
c. End-of-year balances.

3. Foot and cross-foot schedule.

4. Verify accuracy of the schedule:

a. Trace beginning balances to last year's working papers or in case of an initial audit,
establish accuracy of beginning balances by:
aa. Test tracing prior years' recordings and supporting documents.
bb. Trace beginning balances to general ledger balances.
b. Trace proceeds to cash receipts records for additional issues or subscription to capital
stocks and reissues of treasury stocks.
c. Trace payments for capital stock retirements and acquisition of treasury stocks to cash
disbursements records and cancelled checks.
d. Agree working paper ending balances with the general ledger balances.
e. Trace authorizations by reference to minutes of meetings of the board of directors and
stockholders.

5. Where the client is being serviced by an independent transfer agent or registrar:

a. Confirm
aa. Capital stock issued
bb. Treasury stock
b. Arrange for inspection and count of treasury stocks.

6. Where the client does not maintain an independent transfer agent or registrar:
a. Obtain from corporate secretary a schedule of:
 aa. Stockholders
bb. Subscribers
cc. Subscription receivable
dd. Treasury stocks
b. Foot and cross-foot the schedule
c. Test trace to stock and transfer book.
d. Trace balances per schedule to general ledger balances.
e. Inspect and account for:
aa. Unissued stock certificates
bb. Cancelled stock certificates
cc. Treasury stocks certificates
f. Determine that treasury stocks are endorsed in favor of the corporation.

7. Confirm subscription receivables and consider collectability.

8. Review articles of incorporation, by laws, and minutes related to capital stock and related
accounts.

9. Obtain or prepare analyses of other equity accounts, indicating :

a. Beginning-of-year balances
b. Additions and deductions during the current year.
c. End-of-year balances.

10. Foot and cross-foot the schedules.

11. Verify the accuracy of the schedules:

a. Trace beginning balances to last years' working papers or, in case of an initial audit,
establish accuracy of beginning balances by
aa. Test tracing to prior years' recordings and supporting documents.
bb. Trace beginning balances to general ledger balances.
b. For current year transactions:
aa. Ascertain authorization
bb. Determine propriety of accounting treatment
c. Agree working paper ending balances with general ledger balances.

12. Reconcile dividends paid to rates authorized in directors' minutes.

13. Ascertain compliance with requirements relating to capitalization and retained earnings by:
a. SEC and other regulatory bodies
b. Contractual obligations.

14. Determine propriety of financial statement presentation and adequacy of disclosures.

 8 PROBLEMS
Problem 8-1
Analysis of Various Equity Transactions
Burma Company is authorized to issue 300,000 of $2 par value ordinary shares. The company has
the following transactions:

a. Issued 60,000 shares at $30 per share, received cash.

b. Issued 750 shares, selling at $35 per share, to lawyers for services in connection with the
organization of the corporation. The fair value of the legal service was $27,000.
c. Issued 900 shares, valued objectively at $30,000, to the employees instead of paying them
cash wages.
d. Issued 37,500 shares in exchange for a building valued at $885,000 and land valued at $240,000
The building was originally acquired by the investor for $750,000 and has $300,000 of
accumulated depreciation; land was originally acquired for $90,000.
e. Received cash for 19,500 shares issued at $38 per share.
f. Issued 12,000 shares at $45 per share; cash received.

Required:
Compute for the amount of share premium that should be reported in the statement of financial
position.

Problem 8-2
Computation of Total Shareholders' Equity

Israel Company is authorized to issue 200,000 of $10 par value ordinary shares and 60,000 of 6%
cumulative and nonparticipating preference shares, par value $100 per share. The company
engaged in the following share capital transactions through December 31, 2019:

a. 50,000 ordinary shares were issued for $650,000 and 20,000 preference shares for machinery
valued at $2,600,000.

b. Subscription for 900 ordinary shares have been taken, and 40% of the subscription price of $18
per share has been collected. The shares will be issued upon collection of the subscription
price in full.

c. 2,000 treasury ordinary shares have been purchased for $12 and accounted for under the cost
method.

The post-closing retained earnings balance at December 31, 2019 is $420,000.

Required:
Prepare the shareholders' equity section of the statement of financial position per December
31, 2019.

Problem 8-3
Treasury Shares

The shareholders' equity of Norway Company as of December 31, 2018 was as follows:

Ordinary shares, $10 par, authorized 300,000 shares; 250,000

shares issued and outstanding
Share premium-issuance
Retained earnings

On June 1, 2019, Norway Company reacquired 40,000 ordinary shares at $40. The following
transactions occurred in 2019 with regard to these shares.

July 1. Sold 15,000 shares at $48.

Aug. 1. Sold 19,000 shares at $27.
Sept. 1. Retired 1,000 shares.

The following entries were made by the company's accountant to record the preceding transactions:

2019

June 1. Treasury shares 1,600,000

Cash

July 1. Cash 720,000

Treasury shares

Aug. 1. Cash 513,000

Treasury shares

Sept. 1. Ordinary shares 10,000

Treasury shares

Norway Company's net income for 2019 was $135,000.

Required:
Based on the preceding information, determine the correct balances of the following accounts
per your audit:
1. Treasury shares
2. Ordinary shares
3. Share premium-issuance
4. Share premium-treasury
5. Retained earnings (before appropriation for treasury shares)

Problem 8-4
Share Warrants

Libya Company wants to raise its working capital. After analysis of the available options, the company
decides to issue 6,000 shares of $30 par preference shares with detachable warrants. The
package of the shares and the warrants sells for $120. The warrants enable the holder to purchase
6,000 shares of $10 par ordinary shares at $40 per share. Immediately following the issuance of
the shares, the share warrants are selling at $10 per share. The market value of the preference
shares without the warrants is $90.

Required:
1. What amount should be assigned to the share warrant issued:
2. Assuming that only 80% of the warrants are exercised, what is the entry to record the
exercise of the warrants?

Problem 8-5
Analyzing Various Shareholders' Equity Transactions

You have been assigned to the audit of Maryland Company, a manufacturing company. You have
been asked to summarize the transactions for the year ended December 31, 2019, affecting
shareholders' equity and other related accounts. The shareholders' equity section of Maryland
Company' December 31, 2018 statement of financial position follows:

Ordinary share capital, $2 par value, 1,000,000 shares

authorized, 180,000 shares issued, 177,580 shares
outstanding
Share premium-issuance
Share premium-treasury shares
Retained earnings
Treasury shares, 2,420 shares at cost
Total shareholders' equity

You have extracted the following information from the accounting records and audit working papers.

2019
Jan. 15. Maryland Company reissued 1,300 treasury shares for $40 per share. The 2,420
treasury shares on hand at December 31, 2018 were purchased in one block in 2017.

Feb. 1. Sold 180, $1,000, 9% bonds due February 1, 2029, at 103 with one detachable share
warrant attached to each bond. Interest is payable annually on February 1. The fair
market value of the bonds without the share warrants is 95. The detachable warrants
have a fair value of $50 each and expire on February 1, 2020. Each warrant entitles
 the holder to purchase 10 ordinary shares at $40 per share.

Mar. 6. 2,800 ordinary shares were subscribed for at $44 per share. 40% of the subscription was
collected.

20. The balance due on 2,400 shares were received and those shares were issued.

Nov. 1. There were 110 shares warrants detached from the bonds and exercised.

Maryland Company's net income for 2019 is $950,000.

Required:
Based on the preceding information:
1. Prepare journal entries to record the transactions above.
2. Determine the correct balances of each of the following per your audit report:
a. Ordinary share capital
b. Share premium-issuance
c. Share premium-treasury shares
d. Retained earnings (before appropriation for treasury shares)
e. Treasury shares
f. Total shareholders' equity

Problem 8-6
Retained Earnings

The following information has been taken from the ledger accounts of Chile Company:

Total net income since incorporation

Total cash dividends paid
Carrying value of the company's investment in Yemen Company
declared as property dividend
Proceeds from sale of donated shares
Total value of stock dividends distributed
Gains on treasury share transactions
Unamortized premium on bonds payable
Appropriated for contingencies

Required:
Compute the current balance of unappropriated retained earnings.

Problem 8-7
Cash dividend

The following selected accounts were taken from the December 31, 2019 trial balance of Indiana
Company:
 Subscribed share capital
Treasury shares, 600 shares at cost
Unissued share capital
Share premium
Appropriation for plant expansion
Retained earnings
Authorized share capital-100,000 shares
Subscription receivable

The minutes of meetings of the board of directors reveal that on December 5, 2019, the company's
board declared a 10% cash dividend payable to the shareholders and subscribers of record on
December 20, 2019. The dividend checks are to be distributed on January 10, 2020. The
company's accountant has not recorded this dividend declaration.

Required:
What is the amount of unrecorded dividend payable?

Problem 8-8
Share Dividend and Share Splits

The capital accounts of Bahrain Company on June 30, 2019, are a follows:

Ordinary shares, $10 par, 50,000 shares issued and outstanding

Share premium
Retained earnings

The company's ordinary shares are selling at this time at $20.

Required:
What entries would you make in each of the following cases?
a. A 10% share dividend is declares and issued.
b. A 30% share dividend is declared and issued.
c. A 4-for-1 share split is declared and issued.

Problem 8-9
Computation of Book Value Per Share

Poland Company began operations in January 2017, and reported the following results for each
of its three years operations:

2017 300,000 net loss

2018 30,000 net loss
;2019 3,950,000 net income
At December 31, 2019, the company's capital accounts were as follows:

5% cumulative preference shares, par value $100; authorized,

100,000 shares; issued and outstanding, 60,000
Ordinary shares, par value $10; authorized, 1,000,000 shares;
issued and outstanding, 800,000 shares

Poland Company has never paid a cash or share dividend and there has been no change in the
capital accounts since it began operations.

Required:
1. What is the book value of the preference shares on December 31, 2019?
2. What is the book value of the ordinary shares on December 31, 2019?
Assume that the preference shares have a liquidation value of $105 per share:
3. What is the book value of the preference shares on December 31, 2019?
4. What is the book value of the ordinary shares on December 31, 2019?
 quity Transactions
. The company has

ction with the

of paying them

d valued at $240,000
300,000 of

statement of financial

hareholders' Equity

and 60,000 of 6%
The company

ares for machinery

cription price of $18

he subscription

d for under the cost

ition per December

Treasury Shares

$ 2,500,000
3,500,000
1,740,000

The following

ceding transactions:

1,600,000

720,000

513,000

10,000

e following accounts
 Share Warrants

e options, the company

rrants. The
e holder to purchase
g the issuance of
of the preference

try to record the

quity Transactions

ompany. You have

19, affecting
on of Maryland

$ 360,000
3,640,000
45,000
649,378
(145,000)
$ 4,549,378

udit working papers.

The 2,420
e block in 2017.

etachable share
ary 1. The fair
chable warrants
warrant entitles
he subscription was

Retained Earnings

$ 3,200,000
150,000

600,000
150,500
420,000
375,000
413,200
700,000

Cash dividend

alance of Indiana
 $ 1,250,000
90,000
6,000,000
180,000
500,000
1,200,000
10,000,000
320,000

019, the company's

ers of record on
2020. The

nd and Share Splits

$ 500,000
250,000
3,135,000

ok Value Per Share

results for each

 $ 6,000,000

8,000,000

no change in the